Due to the debt ceiling talks in Washington, small business owners have been urged to reallocate debt. Even before that step, however, it’s probably a good idea to really think about the borrowing needs of your business. Do you really need credit?
According to experts, businesses don’t necessarily need to borrow and should only do so for capital expenditures - like equipment and technology, and for short-term cash flow.
Not every business needs to have debt, according to an article on the American Express OpenForum Blog. It offers some (somewhat obvious) advice like managing cash flow so the business does not need to borrow. Most cash necessary to grow business can come from profit and the proper management of accounts receivables, accounts payable and inventory levels.
If a business does need to borrow, financial statements, and not sales forecasts, will tell how much a business can afford. Here’s how to figure it out yourself:
1. Read the balance sheet. The quick ratio (current assets divided by current liabilities) will show the company's ability to pay its short term obligations. In most industries, this should be greater than one.
2. Studying the cash flow statement: this is the most forgotten financial statement and the one that never lies. This will tell the owner whether they have enough cash flow to pay back their debt and at what rate.
3. Checking the borrowing base: For most bank loans, it is 75 percent of current receivables and 25 percent of the value of current inventory. Again, this is a crude method that banks use to ensure that if they have to liquidate a business, they can cover their loan.
There are other ways to find money to keep your business running. Find ways to check your debt ceiling pulse here.