Imagine if you owned, managed or worked for a debt-free business. How would it differ from your current situation? As an owner/manager, how different it would be? Could you imagine that a debt-free business could generate more profits at a smaller size? Could you conceptualize that growth and infrastructure could be self-funded and slower, yet more profitable?
Debt-Free: The Process
What is the first major step to becoming debt free as a business? The first thing required is to understand where all your debt is and how it is being used, as well as how it is impacting your profits and cashflow.
Debt enables a business to take actions because it has ready access to capital. This may be viewed as changing the timing of when something would happen, or it may enable the business to grow at a pace that is not normally sustainable. However, the access to capital comes at a cost, directly as interest and indirectly by enabling the business to increase its infrastructure, which translates to ongoing increased costs that have to be “covered” in the pricing of the business.
The business becomes less flexible and at higher risk as the amount of funds coming into the business go toward making debt payments and the interest associated with those “past actions” increases. The business pays more for all purchases in debt, and on the flip side, when extending credit to customers the carrying costs of those sales reduces the profit margin. Debt utilized by the company and extended to customers creates cash flow impacts and reduces the overall amount of funds available to the organization.
Second rethink how your business would operate if you paid cash for everything. You could be more competitive by being able to reduce your price to the customer and potentially make as much or more profit by reducing the amount of funds going to support the business from borrowing.
Let’s follow a simplified example transaction. You pay $25,000 cash to your employees for their labor. You purchase $10,000 of supplies and negotiate with suppliers a 10% discount for paying cash. Your customer owes you $50,000, which is the full invoice if paid on 30-day terms, but you offer the customer a 5% discount if he/she pays within 10 days. If you borrowed the needed funds at 24% simple interest; then moving to a cash based business nets a $1,370 reduction in cost.
|Item||Debt Business||Cash Business|
|Sales Discount 5% for cash||($1,000)|
|Cost of Financing Customer Balance (20 days 24% simple interest)||670|
|Net Sales Revenue||$50,000||$49,000|
|Salaries and Wages||$25,000||$25,000|
|Interest on Borrowed Funds 24% (simple interest)||500||0|
|Interest on Borrowed Funds 24% (simple interest)||200||0|
|Net Receipt of Funds by Company||$13,630||$15,000|
This is a very simplified example and doesn’t apply to every situation. Each business needs to develop a discount strategy with vendors and customers that works. Overall though, being debt free will put money in your pocket, enabling you to have more flexibility and obtain more favorable terms for doing business.
Third make a plan to get out from under your debt burden. Freeing your business from the debt cycle may just make the difference in struggling through tight economic times versus being able to grow successfully and remain viable in any economic situation. Debt-free small businesses compete for resources and for customers more effectively, and ultimately grow stronger, bigger profits and yes, grow the business bigger in the long run. It’s at a slower rate but ends up larger than under a debt-financing strategy.
Take these immediate steps toward the goal of becoming debt free:
- Analyze where your money goes.
- Understand the profitability of each customer.
- Develop a budget.
- Use the budget as a decision-making tool; if something needs to be done that isn’t on the budget, what will be postponed or eliminated that was already in the budget?
- Prevent expenses and costs rather than always being in a cutting costs mode.
- Decide if the business is the right size for the cash flow it generates. Can you make more money being smaller when you eliminate the debt and related interest?
- Rethink your business in how you staff, market and operate. Consider a new perspective on “how you’ve always done things” to find new approaches and cost-saving opportunities.
- Stay on top of your financial situation and make sure you control the spending throughout the organization. Know the numbers and run the business with the numbers in mind.
- Focus the business on revenue generation as much as cost control.
- Establish three critical measures for growing your business: Revenue, Profits and CASH!
Copyright ©2009 Lea A. Strickland, F.O.C.U.S. Resource, Inc.