Use debt to your advantage

IMPLEMENT PROPER CHECKS SUCH AS FREQUENT RECONCILIATION, REVIEW AND TIGHT CREDIT CONTROL

THE word “debt” often has negative connotations, as if it’s something to be avoided at all costs. As far back as the 1700s, American politician Benjamin Franklin was said to have advised that people should “rather go to bed without dinner than to rise in debt”.

Such fears and warnings are due to debt being widely perceived to spell financial trouble but, in business, more often than not it is a vital, nourishing resource that allows a business to grow.

Debt has specific advantages over equity as a source of business finance. It is often cheaper, can be a more readily available source of finance compared to equity, and does not come with potential shareholder politics.

Debt starts to become a problem only when it is not properly managed. Although profitability, asset growth and happy employees might all be the obvious outward signs of the success of a business, a crucial additional indicator signifying the financial health of a business is the way in which its debt is managed.

This starts with the fundamentals of good overall financial management, beginning with the implementation of a sound control environment, which includes the implementation of necessary processes and checks such as controls over the access to bank accounts and regular reconciliation and reviews.

Another control measure to consider is tight credit control to ensure that your debtors pay on time and you exercise control over their credit terms.

To enable effective decisionmaking, other debt-management measures include implementing appropriate budgeting and forecasting processes. Such processes, if effectively implemented, can ensure robust cash-flow monitoring such as planned cash inflows from sales as well as anticipated cash outflows from expenses and overheads.

Once the all-important financial management fundamentals are in place, half the battle is won when it comes to debt management, but there is more to it.

Often the weakest part of any system is 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.

In other words, if your financial manager has poor control over his or her personal finances, the chances are they might not do a good job of managing your company’s debt. It is important to keep this in mind when appointing a financial manager. You are looking for competent people with sound financial discipline.

A healthy business can use financial ratios to manage its debts. An example 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.

Times-interest-earned ratio is another key measurement for debt management. It is calculated as earnings before interest and tax divided by the business’s interest expense. It measures the ability of a business to meet its interest obligations through its earnings.

In any business, the owner should be familiar with the ratios and make sure they are reviewed at least monthly by the financialmanagement team.

Sound debt management is not only about the cold figures, but also about human relationships. Maintaining a good relationship with your bankers can make the difference between a loan facility being extended or called up.

The relationship must be based on regular and transparent communication by reporting in a clear and simple manner, which will often put your bankers at ease and build trust.

When there is trouble on the horizon, call the financier before they call you and be honest about the problem.

A good payment record, sound financial ratios and a good relationship with the financier can often allow entrepreneurs to renegotiate the terms of their facilities – not only the interest rate, but also fees, service charges and repayment periods.

When you shop around for finance, it is not enough just to look at the interest rates and the size of the instalment. Look out for the administration fees and service charges.

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.

The loan covenants are parameters agreed to with the financier that your business must stick to.

You will also be expected to remain below an agreed level of bad debts.

Often there is a good argument to 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 kneejerk reaction by many entrepreneurs is to keep the problem hidden from the financiers to the point of avoiding their phone calls. This is a recipe for making the crisis worse.

Bierman is managing director at Business Partners.