Quick question: how much money does your small business spend on debt repayments every month?
Is that number higher than you’d like it to be? You’re not alone.
Unless you’re independently wealthy or have the backing of an angel investor, your small business probably needed a loan to get off of the ground. On top of that, you may be using credit cards and lines of credit to stay afloat during the quieter months.
Many people talk about loans like a good thing. After all, they allow your business to operate when you don’t have the capital on hand.
On the other hand, that debt can weigh on you like a tonne of bricks. In Australia alone, small businesses carry $10.4 billion in debt, and a whopping 62 percent of that debt is overdue.
Even if you’re on top of your debt repayments, that debt could be costing your business more than you realise.
Read on for a deeper look at what your business debt is really costing you.
How Much Are Debt Repayments Costing You?
Debt is often considered a natural cost of doing business, just like inventory, utilities, or wages. In fact, debt is even tax-deductible for businesses.
To determine how much a loan will cost a business, you would use the Cost of Debt Formula.
This formula is written a few different ways, but the most simple formula goes like this:
Cost of Debt = Interest Expense (1 – Tax Rate)
The Cost of Debt Formula is used to determine the value of a loan against the potential earnings that loan can bring in.
However, that formula doesn’t always show the full picture. There are a few more costs than those numbers show.
Stagnant Cash Flow
The oldest rule of business is that “it takes money to make money.”
Whether you own a retail shop, run a restaurant, or offer online tech support, there are costs that are inherent to doing business. Shops need inventory. Restaurants need ingredients. Then there are wages, marketing costs, and more.
When you take on debt to pay for these things, the cost of the monthly payments ties up your incoming revenue and prevents you from spending money on things that can grow your business.
For example, let’s say that you spend $250 to buy t-shirts for your business. By the end of the month, you’ve sold them for $1,000 in gross sales.
If you have no debt, you can use all of that money ($750) to purchase more inventory, or you can take it home as profit.
On the other hand, if you took a loan for that $250, you have to pay that loan back before you can decide what to do with the money. Instead of $750 in profit, you only have $500—and that’s not considering any interest.
The margins in this example are still pretty healthy, but many businesses struggle to make enough to pay for their overhead and debt payments, let alone make a profit.
Having debt looming dramatically increases your expenses leaving less money for staff, resources, paying yourself and PROFIT. Profit that could be used to re-invest and grow the business faster.
Debt really does limit your budget and possibilities of expansion, but it’s not the only impact. One of the biggest dangers of taking on debt, is interest.
Cost of Interest
No bank lends money free of charge. They make loans for one purpose: to make a profit.
When you take out a loan—whether you take a term loan, use a line of credit, or swipe a credit card on a purchase—the lender adds interest to make sure that they make more money back than they loaned in the first place.
Even credit cards with 0% APR periods are offered because they are profitable for the lending institution.
These offers entice new customers to spend more money than they pay back in the introductory period, baiting and switching customers into a 17% interest rate on a balance they racked up in the tempting glee of 0% APR.
Your business probably hasn’t fallen into the same trap, but the point remains. A $30,000 loan on a 5-year term with an interest rate of 5.5% may seem like a good deal.
But through the life of the loan, you will pay over $4,000 in interest payments.
$4,000 might seem like a small deal compared to $30,000, but if you’re borrowing more—or borrowing at the 17% interest rate common with credit cards—it adds up quickly and eats into your profits.
With the money you have coming in quickly floating straight back out to lenders it’s really tricky to try and grow your business and get on top of things. You may also find that when you crunch the numbers of how much your total debt and interest is really costing you, you may find that your product and service pricing is no longer profitable.
Loss of Potential Profit
The biggest cost of debt repayments, however, isn’t just in dollars and cents: it’s where those dollars and cents could go otherwise.
If you’re paying $1,000 towards loan payments every month, that’s money that comes through your cash register, into your bank account, and then out to your lenders.
But what if you didn’t have to pay those lenders?
What would your business look like if you could keep that money in your business instead? That would look like a pretty good month, wouldn’t it?!
Let’s look at it over a few years though…
Think of all of the money you’ve paid to your creditors through the life of your business. What if that was profit instead?
If you’re still dealing with debt repayments, you aren’t just stagnating your budget and paying more than you need to… You’re robbing yourself.
Use Profit First to get out debt faster
Your debt repayments aren’t just an annoying part of doing business: they’re hindering your business potential.
You might think that keeping that money as profit sounds too good to be true, but it isn’t. You can make that dream scenario a reality with the Profit First system.
Profit First is a revolutionary money-management system that can turn any business—of any size, in any industry—into a well-oiled, debt-free, profit-generating machine. Not only that but it’s revolutionary money management system enables business owners to stop drowning in debt and get into the black.