Can debt be good for small businesses?

04 April 2018 | Web Article Number: ME20189239

SMME Development & Support
Can debt be good for small businesses?

THE word “debt” often has negative connotations for small businesses as it can be associated with financial trouble. However, it can be a vital resource that allows a business to grow.

This is according to Siphethe Dumeko, chief financial officer of Business Partners Limited, who says that although outward signs of a successful business are profitability, asset growth and happy employees, a crucial additional indicator signifying its financial health is the way in which it manages its debt.

“Well-managed debt starts with the fundamentals of good overall financial management. This is done by implementing a sound control environment along with necessary processes and checks such as controls over the access to bank accounts as well as regular reconciliation and review of bank statements. Another control measure is tight credit control to ensure that debtors pay on time,” Dumeko said.

“Other debt management measures include the implementation of appropriate budgeting and forecasting processes to ensure robust cash flow monitoring such as planned cash inflows from sales as well as anticipated cash outflows from expenses and overheads.”

He noted that the weakest part of any system is often the people who run it, and the management of debt is no exception. “The personal credit record of a financial manager is often a good indicator of how well they can run the financial affairs of the company they manage. As such, it is important to keep this in mind when appointing a financial manager.”

When it comes to managing a company’s debts, a healthy business can use financial ratios, according to Dumeko.

“An example of this is the debt-to-asset ratio, which measures the size of a business's debt in proportion to its assets and signals when debt levels become too high. A times-interest-earned ratio is another key measurement for debt management.

“This is calculated as earnings before interest and tax divided by the business's interest expense, and measures the ability of a business to meet its interest obligations through its earnings.”

Dumeko said sound debt management is not only about the cold figures, but also about human relationships. “Maintaining a good relationship with your banker can make the difference between a loan facility being extended or called up. In order to do this, it is imperative to base the relationship on regular and transparent communication and building trust.”

He added that regularly reviewing the funding options in the market is part of good debt management. “When looking for finance for a small business, it is not enough just to look at the interest rates and the size of the instalment.”

Small business owners should also look out for the administration fees and service charges, and be aware of the penalties that often come with loan agreements such as for settling the debt early, falling behind, and, in some sophisticated facilities, for breaking loan covenants, he said.

“These loan covenants are parameters agreed to with the financier that your business must stick to, such as agreed level of bad debts below which your business will be expected to remain.”

He said a good argument could often be made in favour of consolidating a business's various loans into one facility. Not only does it make the administration of the loan and the relationship with the financier simpler, but it can bring significant savings.

Good debt management skills become even more important in times of business stress. “The knee-jerk reaction by many entrepreneurs is to keep the problem hidden from the financiers making the crisis worse by having the facility called up. In contrast, open and upfront communication can turn a small business’s financier into an ally who may be willing to extend its facility or arrange a repayment moratorium.”

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