How much debt financing is right for a business? In today’s low-cost money environment, the “easy” answer might be “as much as you need” because it is inexpensive (depending on a company’s financial situation). However, the credit environment has tightened significantly during the past two years because of the stress that has been placed on the financial markets. Low-cost money really isn’t that easy to come by.
Possibly the more important question may be, what would it take to run the business without any debt? As the B2B CFO for a number of small- and mid-sized businesses, I can attest to the fact that operating a business on the cash flow generated from operations is easier and less stressful than being saddled with a lot of debt. It also increases control over the company.
With a good focus on cash flow and a deliberate plan to reduce debt, it is possible to achieve the objective of becoming a debt-free company. The elements of a robust cash flow plan will likely include a sound understanding of the classic elements of the sources and uses of cash. In simple terms, you want to increase the sources of cash and reduce the uses of cash to the extent possible.
Sources of cash:
· Improve the efficiency of revenue generating processes
· Collect customer receivables faster
· Turn inventory faster and reduce the inventory balance
· Lengthen supplier payment terms, request early pay discounts, or take full use of existing terms
· Reduce operating expenses
· Increase gross margin of products or services
Uses of cash:
· Increase working capital in all its forms — A/R, inventory, etc.
· Increase interest expense as a result of increasing debt or rates
· Increase operating expenses – payroll, benefits, rent, travel and entertainment
· Capital expenditures
· Add employees or contractors
· Decrease gross margin
Successfully implementing these actions so that the sources outweigh the uses will increase cash flow in the business. The CFO is then able to turn this into a comprehensive financial plan to determine when the business can be debt-free. Without debt in the business, owners are no longer reliant on other entities for success.
Debt isn’t always a detriment. In fact, by the end of the year, my firm will have helped clients obtain more than $200 million in debt financing. These clients have largely been growing businesses in which a loan can be very helpful to support capital expenditures and increased working capital to support additional revenue. When used properly, growth-supporting loans are paid off when revenue growth and increased profitability are achieved.
Unfortunately in a difficult economy, too much reliance on debt has become a way of life for many businesses versus a vehicle for growth. As we enter a year when the economy has at least stabilized, eliminating or reducing debt is one beneficial goal to achieve for companies.