3 Ways to Use Small Business Debt Strategies for Growth

Posted at 06:26h in Small Business Success by Pretha Yasmin

Debt does not always mean financial hardship or struggles, especially in business. It may mean you’re using financing to grow your business or an emergency loan in times of natural disaster. Business debt can be the stepping stone to bring your company to the next level by upgrading processes and machinery or maintaining operations during a tough time.

When used strategically, debt can set your business apart from the competition, giving you the edge to advance in market share and grow revenue. These three strategies take standard debt concepts and explore how they can give you an advantage to fuel growth and leave your competitors behind.

Debt consolidation

Equipment financing

Receivables financing

Debt Consolidation for Growth

Debt consolidation is where you pay off multiple loans with a new single loan and, in many cases, lower your interest rate to save money.

The three main benefits of consolidating business debts into a single loan are:

Lowering your rate: If you currently have three loans, each with a $100,000 balance remaining, and your rates are 10%, 13%, and 14%, then your overall rate is 12.33%. A new $300,000 loan at 11% would pay off the other loans and save you almost $4K per year, which can be reinvested for growth.

Shortening payback periods: A debt consolidation loan with a shorter payoff period makes operations simpler by tracking one loan versus three and will cost less in total interest payments. Shorter payback periods are a good choice when you have extra cash flow to cover higher monthly payments because you’ll pay less interest over the life of the loan and because your business credit score will grow faster as you pay off the loan in less time.

Lengthening payback periods: On the other hand, you can lower monthly payments by spreading payments across more months. By lowering the amount you owe each month, you have more cash flow to reinvest into growth drivers like advertising for new customers.

Keep track of your interest payment average and what the market is doing. If a new low interest rate comes out and you still have a large amount of time left on your current business loans, it may be a good idea to do a business debt consolidation loan and free up some cash flow.

Advanced Business Debt Consolidation Strategy

There are advanced ways to use business debt consolidation and open operating flexibility. The goal is to lessen the restrictions from loan agreements like interest coverage ratio requirements.

If two of your loans require interest coverage of 1.25 but the other one requires 1.5, then your earnings before interest and taxes (EBIT) must be 1.5 times your interest expense. Otherwise, you’d breach the loan agreement. So, if your total interest expense is $36,990, you need to keep EBIT above $55,485.

Negotiating a 1.25 coverage ratio on a debt consolidation loan lets you get rid of the more restrictive (1.5 times) covenant and opens up almost $10K you can use for growth, because you now only need EBIT to be above $46,237.50. You could invest the $10K as a signing bonus for a new salesperson, into advertising for new customers, or other growth ideas.

Getting a debt consolidation loan with less restrictive terms, plus a lower rate or different payback period, would open up even more flexibility for making growth investments.

Financing New Machines for Growth and Efficiency

Debt like equipment financing can grow your business by increasing production capacity, cutting maintenance costs, and lowering labor and rent costs from a more efficient use of people and space. Once you have increased capacity, you still need to find customers for the product and that is where our advanced technique comes in.

Borrowing money from customers is a unique way to finance equipment. This might sound counterintuitive, but it is a great option when you both benefit. Take this example for a company that makes shopping carts and sells them to a supermarket.

The cart company can produce 10,000 carts with existing machinery.

The supermarket needs 20,000 carts. They buy 10,000 from the cart company and another 10,000 from a competitor for $100 each.

The cart company can double their production capacity with new machines costing $200,000. They will also lower rent and maintenance costs, and keep labor costs flat. This table compares their current situation versus a scenario with new machines.

	Current Facility	New Facility	Difference with New Machines
Production capacity	10,000	20,000	Increase production by 10,000
Rent	$5,000	$4,000	Save $1,000
Maintenance	$1,000	$300	Save $700
Labor	$100,000	$100,000	No difference (although they have doubled production without hiring new people)

Instead of using standard equipment financing, the cart company negotiates a deal to borrow money from their supermarket customer with the following terms:

The supermarket will loan the cart company $200,000 for new machines at 0% interest.

The cart company will lower their price to $80 per cart (20% discount from $100).

Because of the 20% discount, the supermarket will buy all 20,000 carts from the cart company (and will no longer buy from the competitor).

This table shows how both companies are now better off by using this strategy:

The supermarket saves $400,000 and simplifies their supply chain with one fewer supplier to track.

The cart company grows profit by $601,700 ($401,700 after paying back the $200,000 loan).

		Current	New Debt Strategy	Difference
Cart Company	Revenue	$1,000,000 (10,000 carts * $100 each)	$1,600,000 (20,000 carts * $80 each)	Higher by $600,000
	Expenses (Rent, Labor, Maintenance)	$106,000	$104,300	Lower by $1,700
	Profit	$894,000	$1,495,700	Higher by $601,700
Supermarket	Product Costs	$2,000,000 (20,000 carts * $100 each)	$1,600,000 (20,000 carts * $80 each)	Lower by $400,000

Next time you need to upgrade equipment, see if one of your customers could benefit with this strategy. You can even apply this same strategy to major investments other than equipment, whether you own a logistics company looking to finance warehouse automation or an aerospace company putting dollars into R&D for new rocket fueling technology.

Receivables Financing to Reinvest

Most small businesses use receivables financing when they need emergency cash or want to make a large purchase to grow. Receivables financing is an appealing alternative to using collateral because you’re not risking machinery or assets like real estate, and instead are using a track record of customer purchases and orders.

Using Receivables Financing to Grow

You can use receivables financing to make smaller, short-term investments. Here’s one situation where it can be applied:

A customer takes 45 days to pay based on negotiated terms.

Once you get paid, you can invest for a 15% return on investment.

You can use receivables financing at 10% interest.

When you wait for customer payments, you get paid $100,000 on day 45 then invest at 15% for the remainder of the year. This means you get 15% interest for 320 out of 365 days. You’d make $13,150.68 on the investment.

By using receivables financing, you make 15% for 365 days and can begin investing on day 1. With this method, you can pay off the loan on day 45 when the customer pays. The loan above costs 10% interest for those 45 days, so you make $15,000 on your investment, pay $1,232.88 interest on the debt, and your profit would total $13,767.12. That’s $616.44 more than if you had waited for the customer to pay.

If you had 100 customers and did that 8 times per year with each customer, you make an extra $493,152 in profit that you can use for growth. This is a more advanced way to use business debt for growth, so make sure to talk to an accounting and finance professional, and keep your books organized.

Business debt is not always a bad thing, as it can be used for growth. Whether you’re consolidating it for lower monthly payments, financing new machinery with equipment financing, or using receivables, there are ways you can make debt work for you.