Debt Management for Businesses
Debt reduction is crucial for financial stability and business growth, especially amid rising interest rates. When you manage your debt effectively it lowers interest expenses and improves cash flow, enhancing the overall financial health of your business.
In this article:
→ The biggest debt management challenge facing businesses
→ How the cost of servicing debt has changed
→ What most people get wrong when managing their debt
→ The secret to effective debt management
→ How one business wiped their multi-million debt in 3 years
→ The impact of gross profit and working capital on debt
→ The best way to release cash in your business, fast
→ The secret to paying down debt and reducing interest
Debt Reduction Strategies for Businesses
“With interest rates continuing to go up, one of the challenges we see in business at the moment is quite simply servicing debt and the interest on that debt.
Previously that had been a nominal amount. If you had a million dollars worth of debt, the way interest rates were might not benefit an amount that really impacted your business, that million dollars worth of debt.
How the cost of servicing debt has changed
Now, even though it might not be putting your business in a massive amount of financial stress, the cost of servicing that debt is significantly greater than what it was, one, two, and definitely three years ago.
That leads to the question: what is the fastest way to reduce debt?
I've got a very simple calculation that I like to do, and if you've watched any of our videos in the past, you won't be surprised by the way I believe that you can do it.
What people get wrong when managing their debt
People sometimes get obsessed around, "Oh, if I'm going to reduce my debt, I've got to find a way to get some cash from here and some cash from there, and I get $20,000 from there."
Again, using the million dollar example, $20K from here and another $10K from there, just try to whittle it away bit by bit... but do you know what? You shouldn't be focusing on your repayments.
The secret to effective debt management
What you should be focusing on is on two areas - one on your P&L and one on your balance sheet. And if you improve those areas significantly, you'll release cash into your business that if you continue to grow, you can pay down debt very, very quickly. Let me give you an example.
How one business wiped their multi-million debt in 3 years
Someone we worked with had around about $3 million worth of debt and for around about three or four years, barely paid off any of it. They got it down to around $2.8M in a three-year period - but do you know what they did over the following three years? They got that down to below a million dollars. And you go, "Well, how does that translate? What did they do?"
They focused on these two elements. They focused on improving their gross profit percentage and improving their working capital percentage.
The impact of gross profit and working capital on debt
Quick recap, gross profit percentage is your gross profit dollars, which is your revenue minus your cost of goods sold, so your gross profit dollars divided by your revenue. They focused on increasing that as a percentage while also improving their sales.
The second side of the equation is the working capital percentage. That is how much debtors that is, how much stock that is, how much work in progress minus your creditors you carry relative to your annualised revenue. If you can reduce that working capital percentage down versus your gross profit percentage as your business grows, that means you're going to have more free cash within your business.
How to release cash into your business fast
For example, if you have a gross profit percentage of 40% and a working capital percentage of 20%, you've got a 20% gap between those two numbers. We find if you're a growing business and you can get that gap at 15% or greater - with gross profit being the higher of the two percentages - you will release a lot of cash, which you can use to pay down debt.
The secret to paying down debt and reducing interest
What's the outcome here? If you want to pay down debt in your business, don't focus on the debt. Focus on the operations. If you focus on the operations that will release the cash that will get you to the debt place you want to be, and reduce down that interest charge in your business.
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