February 28 - Books - Business Advice - Finance

What happens when a business gets into significant debt?

Bad debt is not a term business owners love to hear but it’s often a familiar one. Sometimes it’s necessary to start a business with debt in tow – a bank loan that allows you to get things off the ground. In Australia there are thousands of businesses that are currently in debt, some of which can make ends meet and others who won’t be so fortunate. The ATO currently has an estimated $66 billion of uncollected tax payments which gives you a good idea of how common it is for a business to find themselves in debt. So, what happens when this occurs and how can you avoid it from happening to your business?

The most common ways businesses get into debt

Poor cash flow management

Number one is always poor cash flow management. Keeping track of income and expenses, timing or payments, setting a budget… the list goes on. These are all common mistakes that we see with business clients. Often it’s just about education and becoming well versed on what responsible cash flow management looks like. This is one of the biggest reasons to have an excellent accountant – someone to ask before spending big on another piece of equipment, or to pick up on poor cash flow management before it becomes a hole that’s too deep to dig out of.

Over-extending credit terms

More specifically, over-extending credit terms are a huge cause of cash flow issues. When too much credit is extended to customers (for instance, continued supply of coffee beans to a cafe who’s already overdue on the last two months of payments), it means that big amounts of cash owed are built up and not paid. This has a ripple effect on the entire business – it means they can’t then pay their own suppliers, and the cycle continues. 

Unexpected expenses

Unexpected expenses like recruitment costs, losing team members, accidents, natural disasters like the terrible flooding we saw last year and equipment breakdowns can catch businesses out when they simply don’t have the cash reserves to solve the problem. 

Inefficient operations

Inefficient operations is next on our list which includes things like not pricing correctly, costs outweighing income and failure to raise prices when cost of goods have increased. The list goes on. This is where business advisory comes into the mix – a VCFO should be able to identify the inefficiencies before they cost you your business.

Finally we have the competition. Intensely competitive industries with low margins put pressure on businesses to lower prices to win work. For instance volume home builders who operate on small margins – we saw many of these businesses struggle last year with lock in contracts not reflecting the price of labour or materials that have now skyrocketed.

The tell tale signs that business debt is out of hand

The most obvious signs of debt creeping up are falling behind on payments to the ATO for GST, PAYG and Income Tax. The next one overdue superannuation payments, or falling behind on them altogether. This leads to more debt with fines and admin fees incurred. It’s a vicious cycle. 

Taking out high interest loans or maxing out credit cards are both usually short term buffers that signal cashflow problems – and neither of these options are long term fixes. 

Another key tell to be aware of is the stress levels of the business owner and their mental and physical health. As debt increases, these are often the side effects that need the most immediate attention.

What can happen when a business gets into significant debt…

  1. The business fails. Around 60% of small businesses in Australia fail in the first three years and debt is a huge contributor to this state. In fact, the number one reason businesses fail is poor cash flow management. 
  2. Business restructuring. The new SBR regime was structured to help more small business owners survive a rough patch.
  3. Liquidation, Voluntary Administration or Bankruptcy 

How can a business get themselves out of debt?

Your first port of call is to negotiate with creditors, asking to restructure payments and get a manageable plan happening.

Debt consolidation is key. Often with multiple credit cards or high interest loans there may be an opportunity to consolidate.

Refinancing is another good option, particularly if your main creditor is the bank. Speaking to a good broker is paramount. 

Cost cutting measures. Work with your accountant or advisor to understand where costs could be cut and how much cutting can be done. 

How to avoid business debt

  1. Monitor cash flow
  2. Maintain a healthy bank balance 
  3. Strong invoice terms and payment processes
  4. Manage debt effectively (don’t rely on the money that should be going to the ATO )
  5. Diverse revenue streams
  6. Minimal fixed costs (understand your fixed costs vs variable costs)
  7. Know your breakeven numbers
  8. Plan ahead for slower periods

A good advisor and or accountant will mean in most instances that problems are solved before the debt gets completely out of hand.

If you need to chat cashflow, budgets or debt get in touch.