Odds are that you have some debt inside your business; if you didn’t before, you might now after the hit of the pandemic. There are many opinions out there about whether or not to take on debt and about how much debt is too much, but one thing everyone can agree on is that debt requires focus so you can eventually set yourself free from it.
There are three basic things to consider when dealing with debt management: recording and reporting, interest expense, and debt pay down.
You’re in the money
Often, you take so much care with all of the paperwork to get a loan, that by the time you actually receive the money, you just dive immediately back into the business, glad to have the cash and glad to be done jumping through the hoops.
But have you ever read through your entire loan documents? (Come on, be honest!) That document might not be the most entertaining, but you need to take the time to read it to see what you are responsible for as a result of accepting the funds. Some loan agreements require not only timely payments but also financial statement submissions by you on a regular basis. Occasionally those financial statements need to be reviewed or audited too .
You also want to know what will happen if you make a late payment or a prepayment—situations that often come with additional fees. If possible, set up automatic payments from your main business bank account so that the money is “out of sight and out of mind” before the payment deadline comes. This way you will stay in good standing with the bank without a lot of effort.
To keep your financial statements accurate, you will want to record the loan in your accounting software as a liability on your balance sheet. The money you receive from the loan will go into your cash account at the same time. Now, if the loan itself has a due date (a “maturity” date) longer than one year, you will classify this as a long-term liability on your books. As you make payments, you will reduce that liability by the principal portion of the payment while recording the interest as an expense on your profit and loss statement.
There is a price to pay
There’s always a price to pay for the benefits of getting a loan. The interest rate that is assessed on the loan costs you as an expense. This is important to consider when thinking about cash flow and your overall profit because the interest affects both your cash and your bottom line, or net income. You’ll need to remember this when budgeting in the future since you will incur interest expense for as long as you have the debt. How much interest you pay depends on the interest rate you agreed to. The only way to reduce the amount of interest is to pay the debt down faster than the agreement says or to refinance at a later date.
Pay it off or bust
Hopefully, the debt you incurred is helping you to grow your business to a point where it is healthy and thriving. The faster you pay it down, the better off you will be. Typically, a bank provides you with an amortization schedule at debt inception (when you agree to the loan) that shows you the total loan value, the principal payments, and the total interest you will pay if you follow that schedule. Follow those guidelines at a minimum, but if you can, try to pay an extra payment or amount toward the principal, whenever you can. This will reduce the amount of interest you will incur over the life of the debt. It takes discipline, but there aren’t many things sweeter than paying off a loan!
Which do I pay first
If you have multiple debts inside of your business, you may wonder which one to pay off first. There are several ways to approach this, including ranking by interest rate or balance amount. A great way to check which down payment is right for you is to Google “debt repayment calculator” and find one that motivates you into the discipline you need to tackle your debt.
Be a boss when it comes to your debt.
Know what is required of you from the bank, budget for timely payments inclusive of interest, and pay that debt down prior to making unnecessary purchases so you can become debt-free sooner. You’ll never regret spending extra time and energy getting a plan in place to eliminate your debt.