When talking to business owners about their financial situation, a key area I look at is the Balance Sheet under the Liabilities Section. First, I see if it matches with what the loan statements show because if it’s not accurate then it’s not going to give any useful information to evaluate. Second, I look at what types of debt they have, whether it’s vehicle loans, property loans, line of credit(s), or general loans that business owners use as a bridge to help in between the slow times with cash flow.
If there’s a need to get something new every few years, then think about how much is going towards interest, let alone principal, and realize that they don’t increase in value EVER. It’s estimated that a car loses 10% of its value as soon as you drive it off the lot and imagine if it’s involved in an accident which the insurance company says it needs to be totaled. How much of this investment have you made that’s paid off? Yes, you do need vehicles to conduct business, but in the end, you need to determine what you’re paying in the long-term.
Property debt isn’t always good debt, especially if it’s just sitting there and not income producing. It’s worthwhile to sit on and increase its value, but you also should verify if it’s keeping up with what you’re paying in interest on top of the principal. Consider putting together a spreadsheet as to what you’re actually planning to spend from the cost plus interest, and then determine based upon prior year tax rolls if it actually is a worthwhile investment. Realize that if it comes down to a situation to where you need to sell it for a cash infusion, is it something that you can refinance or do you just need to outright sell it, is it even possible.
Line of Credit
The purpose of a Line of Credit is that you draw down on it when you need it and then repay it back when you have the capability to. Yes, they generally have lower in interest rates than a credit card which is a value in savings, but it’s also not the best option if you have money management issues because you end up maximizing it out. It can definitely be a lifesaver because the limits are often higher than a credit card limit, but there’s always a bad side to every option.
General Business Loan
With numerous loan options out there, it’s never easy to get out-of-debt if you’re not careful. A former client’s partner signed up for a loan, got cash the next day, and it helped purchase inventory items that they needed in order to start a new job. Unfortunately, after running the numbers when I did their tax return, they ended up paying 48% in interest in 1 year for what it cost them in the end. Now instead of advertising high interest rates because of government entities, they’ve skirted around the issue by simply calling these interest payments “administrative fees” to make things look above board. Read the fine print, especially if you’re faced with a review of your financials by a bank loan officer or auditor, trying to figure out why you’re paying so much in interest because it makes them wonder if you’re a good credit risk or if they could even be legitimately deductible.
Dwayne J. Briscoe