Debt and Business: Achieving the Right Balance

The U.S. Chamber of Commerce, in a study of small business habits, found that 77 percent of business owners are relying on capital from banks and financial service providers to grow their ventures.

Most entrepreneurs have some degree of debt before they launch, because the costs of starting a business can be high. But – perhaps due to the entrepreneurial spirit – some owners continue to incur debt to prop up their struggling businesses. Taking on more debt without a corresponding increase in profits is a big gamble. Used carefully, loans and lines of credit may make sense for some businesses, and many of the financial pitfalls of business ownership can be avoided, with solid planning.

Preparing for the Worst

Businesses whose profits are highly dependent on the season are usually well prepared to deal with ebbs and flows in profits. For example, restaurants, landscaping companies, and hotels may hire temporary staff in the summer, so they can avoid paying extra staffers year-round. Some changes in business revenue, however, aren’t as predictable.

In 2016, floodwater surged through Ellicott City, destroying homes and businesses. One business owner who had opened her store just two weeks earlier said the flood swept away her inventory.

Entrepreneurs may not be able to make it through extreme floods, fires, or blizzards without incurring additional debt. Having an emergency fund can help businesses get through periods when they must close unexpectedly.

Another option is to secure a line of credit for use in emergency situations. The benefit of this type of lending is that you use only what you need, when you need it, and you have to repay that amount before you can use your line of credit again.

Planning for Growth

Businesses don’t grow organically; growth requires careful planning, and if you grow too quickly or too slowly, it can cause financial setbacks. A big part of growth, of course, is determining when it’s time to hire more people. At this stage, incurring some debt to pay employees may be a logical step, if your forecasting shows that additional staff will allow you to serve more customers and earn more income.

Crunching the Numbers

Debt ratio is your total amount of debt divided by your total assets. If that number is less than 1, you’ve got a reasonable amount of debt. If it’s higher than 1, you may wish to avoid taking on additional debt.

Loans, lines of credit, and credit cards can be helpful for businesses, but there may be other forms of financial assistance worth exploring, too. The U.S. Small Business Administration and other federal agencies offer a variety of grants for businesses, and the Maryland governor’s office maintains a list of state agency grants for entrepreneurs, as well.

If you need guidance about your small business matters, contact the attorneys at contact form if you have any questions about this topic.

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