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Managing Business Debt: A Strategic Approach

Learn how to manage business debt effectively. Understand good vs. bad debt, create a repayment strategy, and use debt wisely to grow your business.

KW
Kevin Wilson
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Business debt isn’t inherently good or bad—it’s a tool. Like any tool, it can build something great or cause damage, depending on how you use it.

The key is understanding when debt makes sense, how to manage it responsibly, and when to pay it down versus invest in growth.

Understanding Business Debt

Types of Business Debt

Term Loans: Fixed amount, fixed payments, fixed period

Lines of Credit: Flexible borrowing up to a limit

Credit Cards: Unsecured revolving credit

Equipment Financing: Debt secured by equipment

Merchant Cash Advances: Advance against future sales

Invoice Factoring: Selling receivables at discount

Good Debt vs. Bad Debt

Good debt generates return greater than its cost:

Bad debt has no productive use or costs more than it returns:

The distinction isn’t the debt itself—it’s what you do with it.

Assessing Your Debt Situation

Calculate Your Debt Metrics

Total Debt: Sum of all loans, credit lines used, credit cards

Debt-to-Equity Ratio: Total Debt / Total Equity

Debt Service Coverage Ratio: Operating Income / Annual Debt Payments

Interest Coverage Ratio: EBIT / Interest Expense

Know Your Terms

For each debt, document:

Understand Your Total Cost

Annual debt cost = Principal payments + Interest payments

What percentage of operating income goes to debt service? Over 30% creates stress on operations.

Strategies for Managing Debt

1. Prioritize High-Interest Debt

If you have limited extra cash, pay down highest-interest debt first:

The math is simple: Paying off 20% interest debt is a 20% guaranteed return.

2. Refinance When Possible

If you have:

Explore refinancing to lower rates. Even 2-3% savings matters over time.

3. Consolidate for Simplicity

Multiple debts create management complexity. Consider consolidation if you can:

4. Match Debt to Purpose

Mismatched financing creates problems. Don’t use a credit card to buy equipment you’ll use for years.

5. Build Reserves Before Aggressive Paydown

Don’t drain all cash to pay debt if you might need emergency funds. Maintain 1-2 months operating expenses minimum before accelerating debt paydown.

Creating a Debt Paydown Plan

The Snowball Method

Pay minimum on all debts except the smallest, which you attack aggressively. When it’s paid, roll that payment to the next smallest.

Pros: Psychological wins build momentum Cons: May not be mathematically optimal

The Avalanche Method

Pay minimum on all debts except the highest interest rate, which you attack aggressively. When it’s paid, roll that payment to the next highest rate.

Pros: Mathematically optimal, saves most money Cons: May take longer to see debts eliminated

The Cash Flow Method

Prioritize debts with highest monthly payments to free up cash flow, regardless of interest rate or balance.

Pros: Improves operating flexibility Cons: May cost more over time

  1. Ensure minimum payments on everything
  2. Build emergency reserve (1-2 months expenses)
  3. Attack highest-interest debt aggressively
  4. When debt is paid, roll payment to next priority
  5. Don’t take on new debt unless it passes ROI test

When to Keep Debt vs. Pay It Down

Keep Low-Interest Debt If:

Accelerate Paydown If:

The Opportunity Cost Test

If you have $10,000 extra:

Low-interest debt can be good to maintain if the alternative use of cash generates higher returns.

Warning Signs of Debt Problems

Early warning:

Serious warning:

Crisis:

If you see early warnings, act now. Don’t wait for crisis.

Getting Out of a Debt Problem

Step 1: Stop the Bleeding

Step 2: Create a Realistic Plan

Step 3: Negotiate with Creditors

Options to discuss:

Creditors prefer some payment to no payment. Many will negotiate.

Step 4: Consider Professional Help

When debt problems are severe:

Don’t wait until it’s too late to get help.

Using Debt Strategically

When Debt Makes Sense

Seasonal working capital: Borrow for inventory in Q3, sell in Q4, repay after holidays

Growth investment: Equipment that increases capacity by 50%, financed at 8%, paid from increased revenue

Acquisition: Buy a profitable business with debt, service from acquisition’s cash flow

Opportunity capture: Time-limited opportunity with clear ROI

When to Avoid Debt

The Debt Test

Before taking new debt, answer:

  1. What specifically will this fund?
  2. What’s the expected return?
  3. How will it be repaid?
  4. What if the expected return doesn’t materialize?
  5. Am I comfortable with the risk?

If you can’t answer these clearly, don’t borrow.

Your Debt Management Action Plan

This Week

  1. List all debts (balance, rate, payment, term)
  2. Calculate debt service coverage ratio
  3. Identify highest-cost debt

This Month

  1. Create debt paydown priority list
  2. Determine extra monthly amount for paydown
  3. Set up automatic payments
  4. Investigate refinancing options

Ongoing

  1. Track total debt monthly
  2. Apply extra cash to priority debt
  3. Avoid new debt unless ROI-positive
  4. Review debt metrics quarterly

Need help managing business debt? At Profit Path Books, we help small business owners understand their financial situation and make strategic decisions about debt. Book a consultation to discuss your situation.

KW

Kevin Wilson

Profit First Professional and QuickBooks ProAdvisor helping small business owners in Utah and beyond achieve financial clarity and consistent profitability.

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