Debt is a part of most businesses' capital structure. A business debt consolidation loan can help make sure a company is getting the biggest benefit at the least cost from the debt on its books. In certain situations, a debt consolidation loan is one of the best moves a business owner can make.
“Debt consolidation or recapitalization is a critical tool for owner operators to use in order to plan for growth, turn around a negative situation, create free cash flow and remove the stress that slow cash cycles can cause," says Richard Trimber, a business and finance attorney with General Counsel in McLean, Virginia.
That doesn't make debt consolidation a never-fail solution to financial issues. Trimber cautions, taking out a bad loan or even a good loan for the wrong reasons can weaken a business rather than strengthening it.
But with those caveats in mind, the potential benefits of debt consolidation mean it can be a useful part of many business owners' financial management tool kits. Here are some of the ways a business debt consolidation loan can help a company.
Boost Cash Flow
One of the most common reasons business owners take out debt consolidation loans is to lower their total monthly debt payments. When a business has a number of revolving credit card balances, equipment loans and other debts, the total of all the required minimum payments can add up to more than would be required for the payment on a single fixed-term consolidation loan.
Make sure the borrowing is part of a broader strategic plan to grow revenue or profit.
—Richard Trimber, business and finance attorney, General Counsel
In that situation, using the proceeds of a consolidation loan to pay off other debts can improve cash flow, boost working capital and help to fund expansion.
Reduce Interest Expense
Business debt consolidation loans can also help improve profitability and cash flow by refinancing high-interest loans into one with a lower interest rate. Gerri Detweiler, education director for Draper, Utah-based small-business finance marketplace Nav, says business owners often contact her organization's credit lending teams looking for ways to reduce interest rates on costly debts.
“They're trying to get out from under it and get more affordable payment terms," she says. “That's pretty common."
A lower interest rate might not be enough to justify a new loan, Trimber cautions. Some loans with nominally lower interest rates may carry fees that will actually increase the cost of borrowing. But if associated fees and other requirements aren't too burdensome, this can be a good reason to consider refinancing with debt consolidation—as long as the loan serves a legitimate purpose.
“If you are getting a better interest rate or taking out more debt for a strategic purpose, that's a refinancing," says Trimber. “If you are consolidating to clear the deck because the books are a mess, find the root cause first and fix that. Otherwise the owner-operator will likely end up either no better off or, worse, in big trouble."
Debt consolidation can also recalibrate a business by freeing up collateral tied up in previous financings. Business lenders sometimes place liens against borrowers' assets to reduce their risk, Detweiler says.
“You might have a lien against all receivables, for example," she says. While using your receivables as security against a loan may help you get a loan from that lender, it could make it harder to get a loan from another lender, Detweiler adds.
Not all loans require collateral, however. Using a no-collateral debt consolidation loan to pay off secured loans could free up business assets for other uses.
Business credit cards can be used to consolidate loans from other sources. And when business owners do that, the cards' built-in expense management tools can help borrowers record, track and analyze spending patterns.
“It's very common for business owners to say, 'I'll take as much as I can get,' and not have a clear plan or budget for spending that money," Detweiler says. “In that respect, business credit cards can be a tool not just for payments, but also for lower-cost financing and keeping track of where your spending is going."
Also, lenders prefer borrowers with complete and accurate financial files. So using a business card to consolidate other loans can make it easier to get a loan later on. It can also motivate business owners to get a better deal.
“If business owners see how much they're spending," Detweiler says, “it's going to drive them to look for more affordable options."
Borrowing by itself isn't a solution to many business problems.
“Make sure the borrowing is part of a broader strategic plan to grow revenue or profit," Trimber urges.
Even with a good strategy behind it, a disadvantageous loan can hurt rather than help. Michael Taggart, the Granada Hills, California-based author of Goodbye Debt, Hello Future and co-founder of DebtReliefCenter.org, says borrowers can reduce risk by carefully examining loan terms.
“Look out for things like balloon payments, variable interest rates, callable notes and others," Taggart says.
“Many business owners focus so much on the new lower payment that they don't fully understand all the features of the financial instrument they are getting into," he continues. “Debt can be dangerous. Take your time and make sure you fully understand all the features of the loan."
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