For many small business owners, debt is a necessary catalyst for growth. But what happens when that debt becomes a mounting burden, casting a shadow over the future you’re trying to build?
In this guide, I’ll walk you through practical strategies to manage and eventually extinguish your debt, giving you a clear pathway to financial freedom.
Understanding Your Debt
Debt comes in various forms, and each type warrants a different approach:
- Short-term Debt: This typically includes lines of credit or credit card balances, usually with higher interest rates but shorter repayment terms.
- Long-term Debt: Such as mortgages or equipment loans, is often structured with lower interest rates but longer payment schedules.
- Debt Services: Overdraft protection or merchant cash advances, which can often be the riskiest and costliest forms of debt.
Understanding what debts you have, their terms, and your obligations can help create a an effective strategy to manage and eliminate them.
Calculating Your Debt-to-Income Ratio
Your debt-to-income (DTI) ratio is a critical metric for lenders and should be for you too. It measures how much of your income goes towards servicing debt each month.
To calculate your DTI:
- Add up all your monthly debt payments.
- Divide that number by your gross monthly income (income before taxes and other deductions).
A lower DTI ratio is a sign of financial health and indicates to lenders that you can handle more debt. For SMEs, keeping this ratio low is key to securing better terms for future sme loan products and managing current commitments effectively.
Strategic Planning for Debt Management
A contingency fund is your first line of defence against further debt. Aim to save an amount equivalent to three to six months’ worth of your business’s expenses. This fund won’t just help you maintain debt payments if revenue takes a dip, it will also eliminate the need for short-term, high-interest debt in emergencies.
Prioritising Payments
When money is tight, it’s important to prioritise your payments. Your strategy should be to pay off the most expensive debt first – typically, this means debts with the highest interest rates. For business owners, this often means tackling credit card balances or other high-interest short-term loans before repaying long-term, lower-interest debts.
Negotiating with Creditors
Don’t be afraid to negotiate with your creditors. In many cases, they’re willing to work with you, as it’s in their best interest for you to be able to repay your debt. This might involve setting up a new payment plan, reducing interest rates, or even settling the debt for less than the full amount.
Ramping Up Repayments
If your cash flow allows, make additional payments whenever possible, even if they’re small. These can add up and make a significant dent in the debt principal, reducing the overall interest you’ll end up paying.
Debt Avalanche vs. Debt Snowball
Two popular methods for repaying multiple debts are the debt avalanche and the debt snowball.
- Debt Avalanche: With this method, you focus on repaying the debt with the highest interest rate first. This approach often saves you the most money in interest payments.
- Debt Snowball: With the debt snowball, you start by paying off the smallest debt first. This method can provide quick wins and a psychological boost as you eliminate individual debts, giving you momentum to tackle the larger ones.
Choose the method that best aligns with your financial situation and psychological motivation.
The Bi-Weekly Payment Plan
For long-term loans, especially mortgages, the bi-weekly payment plan can accelerate your debt payoff. Instead of making 12 monthly payments each year, you’ll make 26 half-payments – the equivalent of 13 monthly payments. This simple adjustment can knock years off your loan repayment schedule.
Seeking Additional Financial Help
For those with good credit, balance transfer cards or debt consolidation loans can be effective tools for managing and reducing debt. They can help you to:
- Combine multiple debts into a single, more manageable payment.
- Secure a lower interest rate, saving you money over time.
Be cautious, however, as these options may come with fees or higher interest rates after promotional periods.
Seeking Professional Help
Financial advisors, debt counsellors, and even specialised small business services are available to assist with debt management. While there may be a cost associated with these services, the knowledge and support they provide can be well worth the investment in the long run.
Preventing Debt Recurrence
If you’ve struggled with debt, it’s essential to assess your budget. Look for areas to cut back or reduce spending, and reevaluate your spending priorities.
For small businesses, this might involve scrutinising operating costs, renegotiating contracts, or finding more cost-effective solutions to your needs.
Employing Credit Monitoring and Management Tools
Staying vigilant is crucial. Regularly monitoring your credit can help you catch any issues early, and employing credit management tools can help you stay on top of your financial obligations.
Using Credit Wisely in the Future
Establishing good credit habits now can prevent future debt issues. This means ensuring that any future sme loan borrowing is well within your means to repay and maintaining a low DTI ratio.
Final Thoughts
Paying down debt is hard work, and you should celebrate your achievements along the way. Whether it’s paying off a specific credit card or reaching a certain percentage of debt reduction, acknowledging your progress can keep you motivated.
Creating a debt management strategy is one thing, sticking to it is another. It’s important to remain disciplined and focused on your financial goals. Regularly review your strategy and make adjustments as needed, but always to become debt-free.
Debt management and repayment can be daunting, but with a clear plan and a commitment to your financial health, it’s an entirely achievable goal. Remember, the road to a debt-free tomorrow starts with the decisions you make today.
