A third of small and medium-sized companies in the UK have business debt that is more than three times their cash balances.
According to the Bank of England, that has risen almost 20% since the Covid pandemic. It can signal that businesses are struggling.
But debt is not always bad. It can be good for your business if it’s used for the right purposes.
Ignoring problems and not understanding bad debt can be a problem, however!
As Rachel Reeves prepares her 2025 Budget, managing debt and budgeting is a hot topic. The UK government’s debt is about to hit 100% of its GDP. That means its debt is equal to the value of all its goods and services in a year and could spell economic disaster! Most SMEs would need to go under if they had the same issue.
In this post, we’ll look at what debt is and some is good and some is bad. And we’ll also consider what steps you can take to understand and take control of the debt in your business.
Good or bad debt?
Debt isn’t always bad, especially in business. For example, many businesses require investment into research and development before having a product or service to sell.
Bad debt is that which money that’s owed to your business that might be difficult to get paid. For example, you may be owed cash from another business that is having their own issues.
It can also mean debt you have taken out, such as an emergency loan at a high rate that you’re now struggling to pay off.
Understanding which you have will help you manage your business debt.
Good debt
As long as debt is planned with a clear investment purpose, then that is a good debt. Low interest rate loans that are carefully planned for investing into the business are a good debt.
If the loan is from a reputable lender, it is also considered good debt. Growth finance from business loans or other low-rate financing is what business owners should prioritise. Many lenders will only consider your loan request if you have a clear strategy in place. They won’t even entertain emergency loans if you have no idea of your current financial situation.
Such investments are usually used to increase demand from customers. This makes it good debt because your business will eventually pay what it owes.
Good debt is also that which you are owed and you’re confident will be paid. If you have regular customers, then encouraging them to pay by standing order or giving incentives for prompt payment is a good way to manage good debts.
Bad debt
As we’ve mentioned, bad debt is money your company is owed but may struggle to reclaim. That includes giving customers extra credit lines or a customer becoming insolvent, which means you won’t receive all you’re owed. In some cases, you won’t receive anything and that can lead to your company being unable to pay its debts.
But bad debt can also be what your business owes to a creditor.
Businesses can often end up in trouble because they haven’t any forecasting in place and didn’t realise they would run out of funds. They will often lurch from one issue to another rather than looking at the bigger picture!
For example, many business owners will consider extending an overdraft if they have a budgeting emergency. But these usually attract high interest rates and can make things go from bad to worse!
What is business debt?
SMEs rely on different types of debt. Some are better than others. These include:
- Loans. Secured loans that are backed by collateral usually attract lower interest rates and are better than unsecured loans. They can help grow your business if used properly.
- Credit cards. These are useful for emergencies or for everyday expenses as they give cash flow breathing space. But make sure you pay balances on time or they become costly with high interest rates that can cripple your business.
- Trade credit. This can help you manage your cash flow by aligning payments to be made to your creditors at the time you get paid.
- Overdrafts. Using an overdraft can be useful for covering short-term gaps in your cash flow. But, remember, the interest rates are usually quite high and you could incur fees if you exceed your limit! Don’t rely on an overdraft.
How to tell if you have a problem
Identifying you have a business debt issue early is essential when it comes to managing business debt.
Having a cash flow forecast and regularly assessing it is essential when it comes to running a business. And it becomes invaluable when monitoring your business debt.
It means you can pick up warning signs of financial problems early. For example, regular cash flow shortages can be flagged up early enough so you can take steps. Shortages can be shown when there is a drop in revenue or costs are increasing leading to cash flow issues.
Or you may spot that debt payments are being missed or delayed. Other signs of debt problems include strained relationships with creditors as you miss payments . Your debt regularly being higher than your revenue is also a clear sign that you may have debt problems.
So how do I manage business debt?
If your business is facing a debt problem, the first thing to do is not to bury your head in the sand. You need to work out what debts are the most important to pay.
What are your priority debts? They are the debts you need to pay because you can’t operate without their services. Debts that come with hefty non-payment and high interest rates should be prioritised. Any debt that could lead to legal issues should also be a priority. These include:
- Mortgage and rent payments
- Tax bills
- Bank loans
- Utility bills
- Payments to suppliers you rely on
- Borrowing with a personal guarantee
Speak to creditors
Never refuse to talk to organisations or people you owe money to. They are more likely to be understanding if you’re honest and keep them updated. It could make a big difference.
Improve cash flow
Cash flow is essential for any business. Improving the amount that flows in and reducing what flows out should be an early step. That can include cutting unnecessary costs. Do you really need that subscription? Other ways to improve your cash flow include:
- Ensuring customers pay on time
- Carrying less stock
- Negotiating your credit from suppliers. But don’t damage your relationship at the same time!
Communicate with other directors
Don’t cover up any problems. Your directors have a legal responsibility in running the business whether or not their expertise is in finance. And senior managers might also be able to help with ideas about improving your cash flow and revenue.
Raise funds
If your business isn’t overwhelmed with debts, it is more likely to be seen as an investment opportunity. Whereas a business with problems will not attract investors or be able to secure good debt.
To help improve your company’s position, you could try:
- Liquidating assets
- Crowdfunding
- Borrowing from friends or family
- Finding a new main investor
But be aware. Don’t get into more debt or difficulties if all the signs are you won’t be able to give back what you owe. Getting independent advice from your accountant or a specialist is always good advice.
What to do next
Don’t leave dealing with debt until it’s too late. And if you are managing your debts but don’t understand how forecasting can help, we can help.
Cash flow forecasts can say so much – but you need to know how to use them. Our team includes experienced people who can quickly interpret cash flow forecasts that reveal the health of your business. They are often key to managing your business finances better. Contact us today for details.
