In these trying times, small businesses are suffering tremendous losses. When the economy is stable, there is little time to worry about issues like the debt to income ratio and break-even points because as long as the revenues continue to flow, it's not a pressing need to have to deal with debt. However, when the customers stop spending, or start cutting back, that's when the issues of debt and spending become vital to the future growth of a business. There are steps you can take to ensure that your small business actually has a future to plan for.
Items you will need
- Profit and loss statements for previous five years.
- Balance sheets for previous five years
- Monthly expenses
- Monthly regular income
Getting a Small Business Out of Debt: Assess the Reality
Whether you have been in business for one, two or more years, debt is going to be a natural part of doing business. The key is to get a handle on the use of the debt as quickly as possible. The first tool to accomplish this is the break-even analysis. To get an accurate break-even analysis you need to get the figures for revenues vs. expenses. Expenses are broken down into two main categories, fixed and variable. Fixed expenses are those which do not change and cannot be reduced or eliminated without a substantial change in the way you do business. These include rent, utilities, payroll, and cost of goods sold. Variable expenses include advertising, marketing and more. Revenues should be calculated by using an average of the monthly revenues from the last several months of doing business. It will usually work out best if you eliminate both the highest and lowest month to calculate the average. If your business works by contracts where the revenue is all but guaranteed, only consider those guaranteed revenues in your calculations. If not, simply use the average method. Subtract the fixed expenses from the revenues, and hopefully you have a positive balance afterward. If not, there may be some extreme measures you will have to take to change this. At this point, the adage that "you have to spend money to make money" will only carry you so far. Your break-even point will be the amount of revenue you have to make to meet all expenses on a monthly basis. If there is a positive balance, now you have to assess the amount you have left with the variable expenses still to be paid, including payment to yourself for your personal bills. Reducing or eliminating variable expenses can be painful, but when it's necessary to save your business from going under, it's much less painful than the extreme measures needed for reducing fixed expenses. If the fixed expenses are leaving you with little room for paying off debt, consider the possibility that you don't actually need some of the "extras" of doing business. Service industries like construction, accounting, lawn care and catering rarely have walk-in business. Is there a true need for the office? Many businesses are now working out of the home and since there is seldom a need to meet clientele in your office, perhaps you could make room in your home for an office. That would eliminate rent and business utilities that tend to be very expensive in comparison to individual accounts. Consider eliminating hard line phones and change to cell only service so that your location will not matter. Eliminate the fads of business promotion. Not too long ago, it seemed every business had its own advertising-wrapped Hummer or SUV. If the vehicle is paid for, keep driving it; if not, consider a cheaper vehicle with the same wrapped ads. Another fad of business is the use of the latest and greatest in communications, upgrading to the newest cell phone each time it comes out can be a tremendous drain especially considering the fact that it usually takes a year or more before the new technology has all its bugs worked out, and if you just wait until you actually need a new phone, usually a year later they are cheaper. Take the iPhone for example. If you had waited just one year, the costs would have been less than half what it was to get an iPhone when it was hot.
Next, grab your profit and loss statements and balance sheets. If you can export all the P&L statements into one spreadsheets, that would be great. Now compare a few of the key figures in these statements. To start, look for the sales or revenues portion of the reports. Are these numbers increasing? By what percentage? A healthy increase would normally be anywhere from 8% to 10% for a new business per year. Now, look at the cost of sales or cost of goods figures. Are they increasing in proportion to the increase in revenues? If the costs are increasing by 15% a year and the revenues are not, then there is an issue to be addressed. Maybe you aren't charging enough for your products or services; maybe you should consider getting the goods from another source for less money. Finally, look at the net income. Anticipate that a new business usually takes about 3 years to break even. Is the net income increasing in proportion to the revenues coming in or are the higher expenses eating up the difference? By what percentage is the net income increasing? If the end result is a comfortable amount that leaves you with enough to pay all expenses and leaves a little for paying yourself, that is always a good thing.
After assessing all expenses, and trimming budgets as much as possible, see if there is an extra $50 or more per month to put towards paying off debt. Some planners suggest aiming for those debts with the highest interest rates first, and that is a good plan. However if a lot of debt you have involves small amounts on each debt, you may want to consider paying off the smallest debts first and move on to the larger ones. If you have a disproportionate number of credit cards, try to scale back to only one, paying off the smaller ones as quickly as possible. Use the minimums that you were regularly paying, plus the extra amounts you were able to budget for and each time you pay off one account add what you were paying for that account to the next largest one. Eventually this snowball effect will pay off the debts within months instead of years. Resist the urge once the debt is gone to go into debt again. Your vehicle may be old, but as long as it is still running, there's no excuse for trying to one-up your business with the latest and greatest of everything by using debt to do it. Your building may be small, but as long as the profits are coming in, don't mess with the success unless you are clearing not only expenses and paying your staff and yourself a healthy income but also saving enough to operate your business should the economy slow down even more than it has recently. For a business, it is good to have at least a 6 months supply of savings just in case. The number of businesses which have failed that were doing well only to take on more debt to try to make more money is astronomical. Bigger locations work sometimes, and it is best to spend money in research before plunging headlong into an enormous amount of debt that current income levels cannot handle. Find a small business consultant before signing anything and do your homework.