There are businesses the world over who aspire to be debt-free. It’s that ideal, that dream of no money worries, which drives many business owners. But is being debt-free really all it’s cracked up to be? Whilst it may be the position so many strive for, in reality it’s not always the best option.
What does being debt-free mean?
There are few businesses that are truly debt-free. But what does debt-free actually mean? Basically, the company does not owe money to any supplier, stakeholder or HMRC. So, the company doesn’t have any loans, any hire purchase or contract agreements, does not owe any money to HMRC in terms of VAT or corporation tax; it has no debts at all.
The slight variation is when the company has sufficient funds to pay its debts when they are due, i.e. it is net debt-free, but it doesn’t necessarily mean it’s paid all its borrowings.
Is it good to be debt-free?
Whilst the ideal of being debt-free is tempting, it’s not always the best option for companies. Indeed, carrying a small amount of debt can actually work in the company’s favour. However, it’s important to note that having a low level of debt is different to cash flow problems.
Having a negative cash flow situation is not good for a company; having a small level of debt can be good for the company. Good debt is a representation of an investment the company has made for the future of the business, i.e. that debt does not have an overall negative impact on the company’s financial situation, and it can be repaid.
When is debt a good idea?
Debt is cheaper than equity
Using a company’s equity for growth comes with its own inherent risks. For example, if you’ve used equity to purchase new equipment, should an unexpected bill need to be paid, i.e. for a repair; it can leave you unable to pay the debt. Sometimes borrowing from a bank or investors can be a less risky option and ensure that sufficient equity still remains in the company should the unexpected occur.
To finance business growth, it is generally considered a better option to source debt from other lenders than investors, and it is often cheaper. Putting money into a company from an investor is considered a risk. In return for taking that risk, an investor will expect to see a healthy return, usually a minimum of 10%. An investor can also change the ownership of the business.
A faster rate of growth
Any business owner wants to see their company grow, but to do that, funds are required for a number of activities, such as investing in new equipment, hiring new employees and promoting the company.
Using the company’s equity, or cash flow, to invest in growth will be a slow process. Sourcing funds from a lender, such as a bank, ensures there is an injection of cash into the company. It can also boost cash flow, increase profitability and grow the company at a faster rate.
Reduces cash flow problems
Every company at some point will experience cash flow problems, be it through late payments, unexpected payments or investing in equipment. It can be hard to put aside funds to invest in growth when the money coming in is either the same or even slightly less than the money going out.
Having a source of credit that is affordable for the company ensures there is capital there when it is needed. Debts can be paid when they are due, cash flow remains fluid, employees are paid and investment can be made for ongoing growth.
What is considered a good level of debt?
When people talk about debt, all sorts of nightmares come to mind. However, debt can actually be good, as long as it doesn’t get out of hand. So what is a good level of debt? Long term debt that incurs a low interest rate, making repayments affordable, is considered acceptable debt.
There are also advantages to having a level of debt when it comes to tax liabilities. If a company has made investments into new equipment, a capital allowance can be claimed. In addition, you can offset debt against corporation tax.
When is debt bad?
For any company that is borrowing, there has to be a limit. Taking out too much debt or debt consolidation loans to pay off other debt, whether they have a low interest rate or not, will eventually lead to the company being unable to afford the repayments. Debt levels will ultimately lead to a situation whereby the company is no longer able to meet its debt commitments.
Debt consolidation companies
For any company that is struggling with debt, getting advice from debt consolidation companies in the form of debt counselling will help. Over the past year, personal and professional debt has risen significantly, predominantly due to the coronavirus pandemic. Ernst Young’s report predicted that UK businesses will have borrowed over £60 billion by the end of 2021. Indeed, the British Business Bank (BBB) recently reported that 45% of UK-based SMEs had applied for financial support in 2020; 89% of those applications were due to COVID-19. Their data also showed that a ‘sizeable number’ were likely to struggle to recover and pay back their debts in 2021.
Debt consolidation companies work with businesses to help them manage their finances and find the best solution to becoming debt free. Depending on the company’s financial situation and the level of debt, a debt consolidation solution is possible and will avoid any court proceedings.
There are various organisations that offer debt counselling services which are very affordable, such as National Debt Advice or the Business Debt Line, who are government-backed.
However, whilst it is beneficial to go down the route of debt consolidation, i.e. making just one monthly payment that is affordable in comparison to several unaffordable payments, there is a debt counselling fee and it may not cover all your debts. If one of your creditors has taken you to court, a debt counsellor will not be able to include that debt in your debt management plan.
If your company is struggling with debt or you are looking for financial advice, the first step is to seek professional help. Our highly experienced professionals at Leading UK are on hand to assist you with any of these issues.