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Most business owners we work with are in debt to some degree, whether it’s in their business, their personal life, or both. 

And there’s nothing wrong with a little ‘financial leverage’.

But for many business owners, debt can become a vicious cycle that’s really hard to get out of. And until they do break the cycle it’s almost impossible for them to feel financially relaxed, let alone financially free.

When it comes to breaking the debt cycle, while every business (and every business owner) is different, the principles are always the same.

In this article, we’ll explore some strategies for breaking the debt cycle and managing business debt effectively.

Create a Debt Management Plan

One of the most effective ways to manage business debt is to create a comprehensive debt management plan. This plan should be designed to ensure you are paying off debts in a sequence that considers not only the costs such as interest and fees, but also getting some early wins by paying off some of the smaller debts as quickly as possible. You’ll feel like you’re making progress that way, and will build positive momentum.

Seek Advice from a Professional

If you find yourself struggling with debt, it’s important to seek advice from a professional. Meeting with your accountant or financial planner can help you understand your options and develop a plan for managing your debt effectively. Your advisor can also help you identify potential areas of risk and recommend strategies for reducing debt over time.

Consider the Big Picture

When managing debt, it’s important to consider the big picture. No one debt should be considered in isolation. Instead, it must be factored into the overall plan. 

Crucial tip: Whenever you are considering taking on a new debt, talk to your accountant or financial planner before committing to make sure it’s factored into the overall plan. There’s far less an advisor can do for you after a loan contract is signed, than before. For example, deciding on the type of loan (there are always options), avoiding personal guarantees where possible, deciding whose name the loan should be in (for tax and asset protection purposes), and so on.

Demonstrate Good Conduct

Obviously banks and other lenders are more likely to loan you money or grant you some grace if you’ve demonstrated good conduct with them. This includes things such as staying within the limits of your facilities and keeping up to date with repayments. If you slip into bad habits, the banks will look at this unfavorably, and it could become difficult to secure new credit in the future.

Understand Credit Scores

Your credit score is an important factor in managing debt effectively. In Australia, every time you miss a bill or loan payment of more than $150 by more than five days, your credit file is marked, and your credit rating takes a hit. On the flip side, the information also includes positive information such as how often you make repayments on time, which can actually help to improve your credit score over time.

The information your financial institution can get as part of an Australian credit check includes:

• whether repayments have been made on time over a two-year period
• whether you paid a bill over $150 more than 60 days late (it will be listed as a default)
• the limits of any credit cards you’ve applied for
• the types of credit card(s) you’ve applied for
• the date your credit account was opened, the type of account, and when it was closed
• whether someone has entered into a new varied arrangement for repayments because of a default.

Know your credit score: You’re entitled to a free copy of your credit report each year. There are also services where you can pay a fee to be alerted whenever your report or score changes. For more information on how to do this, and on the system in general, visit www.creditsmart.org.au.

Plan for change

Even if you have a great credit score and the banks are bending over backwards to loan you money, you still need to be prudent. While a bank may specify the amount you can borrow, it isn’t necessarily the amount you should borrow. 

Instead of looking at what you qualify for, look at what you can afford to repay long-term. And remember to factor in changes to your circumstances such as:

• interest rate increases (assume at least 2% as a rule of thumb)
• children
• relationship breakdown
• a key team member leaving
• a key client leaving
• changes to legislation
• untenanted properties
• low share dividends
• decline in the property market
• decline in the share market
• industry shifts

If any of these happen (and this list is far from exhaustive) will you struggle to meet your repayments? Never borrow money on a best-case scenario. Instead, use your own common sense calculator. (No, you can’t download the app.)

As the Greek philosopher, Heraclitus, is quoted as saying: “Change is the only constant in life.” Don’t hope that change doesn’t happen. Plan for it.

Careful with debt consolidation

Consolidating all your debt into one loan often seems like a good solution. And sometimes it can be, but it needs to be considered within the bigger picture. 

Here are some of the considerations:

Short-term benefit vs long-term costs: Weigh up the short-term benefit of easing cash flow against the long-term potential costs. 

A number of loans are designed to be paid off within a relatively short timeframe (usually five years). If you absorb them into a home loan, you could be turning a five-year debt into a potential thirty-year debt.

Sure, you may be paying a lower interest rate. But you’ll be paying it over a much longer period. And bear in mind it’s compound interest, so while you may experience an immediate reduction in loan repayments you’ll probably end up paying a lot more over the term of the loan.

Keep paying the same amounts: If you decide to consolidate, still pay the regular amounts of the shorter loan payments if you can. Don’t take your foot off the accelerator to pay your debts down, just because a consolidated debt might make that possible.

The fees could be hefty: Be aware of the fees involved in consolidating your loans—particularly if you need to go to a ‘non-conforming’ lender (one that doesn’t conform to the lending criteria of the major banks) and/or have tax debts that need to be consolidated. 

The standard ‘big banks’ generally don’t think consolidating tax debt is an acceptable reason for a loan application. So you often won’t get past first base with them. 

That means you may have to look at a ‘non-conforming’ lender as an option. But given you’re using these lenders for a less-than-ideal reason (previous debts becoming unmanageable, paying tax debts and so on) they consider you a risk and will generally apply a ‘risk fee’ to the loan application. And chances are it won’t be cheap. For example, they could charge you 1.75% of the total loan amount (e.g. $8,750 on a $500,000 loan). So just applying for the loan could cost you thousands. And that’s on top of the legal and other associated lender fees and charges.

So while a ‘non-conforming’ loan may become a necessity, they can be very expensive.

Tread carefully: We’re not saying you should never consolidate your loans. Just make sure you understand the terms and conditions, and what it will mean for your long-term financial position.

Review Regularly — with a Professional

A Debt Management Plan isn’t a set-and-forget process. Circumstances change from one year to the next, so it’s vital you review your plan annually.

Make a time each year to sit down with your accountant or financial planner to:

• Check that your overall debt management structure is still optimum for minimising your costs, taxes and risk
• Review the competitiveness of your loan providers
• Calculate the cost-benefit of switching or staying with providers
• Review your income and expenses to consider adjusting repayments
• Adjust projections, if necessary, for when you’ll be debt-free
  

And with all due respect to banks and other lenders, it’s unwise to use their services for a review of your debts. They’ll have budgets to hit for writing loans, and they’ll have you in their sights. (You wouldn’t go to a car salesperson to seek advice on whether you needed a new car, would you, because you know what the advice will be.)

By instead talking with your accountant or financial planner, you’re getting impartial advice from someone at arm’s length from the transactions.

Time for action

Managing business debt can be a challenging task, but it’s not impossible. By creating a comprehensive debt management plan—and seeking impartial professional advice to create it and review it regularly—you can break the debt cycle and achieve financial freedom.

No matter your current debt levels, there are always options available, so don’t hesitate to reach out to us for guidance.

Let’s chat

Get in touch for more information or to request a complimentary no-obligation chat about your debts—whether business or personal—and to learn about our 8-step Financial Freedom Wheel methodology. This puts you on a clear path to get you where you want to be financially.

The Financial Freedom Wheel™

Managing your finances and staying on track with your money, tax and investments can be hard. With so many moving parts these days—in an increasingly complex and technological world—it can be hard to know where to start or what to do next.

That’s why we’ve developed our 8-step Financial Freedom Wheel™ methodology. 

Developed off the back of our 40+ years in advising clients on how to manage their money, reduce their tax, grow their wealth and create a great lifestyle for themselves and their families, we identified the 8 most important aspects that you need to plan and manage well, in order to reach financial freedom.

We’re so passionate about the Financial Freedom Wheel we wrote a book about it! 

Download a free copy of the Financial Freedom Wheel™ Worksheet here.