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Updated: Mar 31, 2020
Maybe you’re searching for a better interest rate, for example, or find yourself struggling to manage multiple repayments every month. Whatever your reason, you have two options for restructuring your debt: refinancing and consolidating.
Unlike refinancing — which involves replacing an existing business loan with a new loan that has a better interest rate — consolidating debt means getting a new loan to replace two or more current loans. As with most financial decisions, there are advantages and disadvantages to consolidating your debt. Let’s explore them and help answer the question of “how much debt should a company have?”.
Consolidating multiple forms of debt streamlines your payments. When you don’t have to manage different repayments and debt schedules, it’s easier to budget and handle fluctuating cash flow. As a bonus, consolidating your debt may inadvertently boost your business credit score. After all, when you’re juggling multiple payments, you’re more likely to miss one, which causes your credit score to drop.
Getting a new loan to replace existing debts doesn’t automatically get you a lower interest rate or better terms. Consolidating your debt could end up being more expensive. What’s more, if you don’t manage your cash flow well in the wake of consolidating, then combining loans could set you back financially.
When determining whether or not to consolidate your business debt, it’s crucial to evaluate your business’s finances and payment schedules, as well as your stress levels. Examining the seven factors below can help you determine how much debt a small business should have and help you make a smart decision for your own business.
Consolidating your debt might be right for you if:
It’s tricky to juggle multiple forms of debt. If you have three loan repayments each month, you have to keep track of three different principal amounts, interest rates, and payment timelines. Not only does it take more time to monitor and pay off multiple loans, but it also takes more brainpower.
If you’ve missed loan payments in the past because you feel overwhelmed, then consolidating your debt may help. Simplified payments mean less stress and more mental energy to devote to other tasks.
Managing your business’s cash flow is a delicate act at any time, but it’s especially challenging when you have two or more loan payments each month. On top of balancing accounts receivable and payable, you also have to make payroll and set aside enough funds for operational expenses.
An indication that you may soon exceed how much debt a company should have is if your incoming and outgoing payments don’t line up. When this happens, you might struggle to come up with enough cash to maintain operations or make payments on time. Imagine, for example, that you have to pay your heftiest loan two weeks before your client is supposed to pay their invoice. Until you get the money you’re due to you, you may have to scrimp on expenses or delay inventory orders. If you’re at risk of missing payments, or if cash is so tight that your service is suffering, debt consolidation could be the right solution.
Being a business owner means managing hundreds of big and small to-dos every week. If you’re so busy that you don’t have enough time to get through your daily workload or plan for long-term growth, then streamlining your debt payments might free you up to accomplish more.
Maybe you recently ramped up sales and need to retrain your team on techniques and protocol, for example. Or, perhaps you’re preparing to develop a new product line. Eliminating how much debt your small business has doesn’t just reduce the time you spend making repayments, it also saves you time balancing your cash flow, budgeting for monthly expenses, and tracking your loan progress.
If your business loans have prepayment penalties — or fines for paying off your loan early — then consolidating your debt could result in paying a couple of hefty fees. Prepayment penalties can upset your cash flow and make it difficult to recover, even if you receive a lower interest rate on the new consolidated loan.
On the other hand, if you don’t have prepayment penalties on your business loans, then you’re in a better position to consolidate your debt, since terminating your loans won’t result in extra fees.
If you’re considering consolidating your debt and you’ve recently gotten a boost on either your personal or business credit score, that’s a good sign. Improvements in your credit score can help you get more favorable loan terms. Not only do you have a better chance of getting approved for a new loan, but you’re also more likely to receive a lower interest rate and a more flexible repayment schedule.
How much debt should a small business have? As a general rule, you shouldn’t have more than 30% of your business capital in credit debt; exceeding this percentage tells lenders you may be not profitable or responsible with your money. Plus, relying on loans for one-third of your operating money can lower your business credit score significantly. In turn, it’s harder to get an affordable interest rate, let alone get approved for a loan.
If you have multiple forms of credit, consolidating your debt can help improve your credit score and increase your chances of receiving additional funding down the road.
When your business is thriving, you have a better chance of getting approved for a consolidation loan with favorable terms. Start by reviewing your finances over the past year to check your revenue, profits, and expenses. If you’ve managed to bump up your sales or revenue while lowering your costs, for example, then lenders may be more likely to approve you for a new loan.
Consolidating your business debt can help with tight payment schedules, and debt overwhelms, but it’s not a perfect solution. To ensure you’re not just putting a bandaid on the more significant problem of how much debt your small business has, take a closer look at your financial habits. That includes evaluating the factors that contributed to your decision to take out multiple loans in the first place.
Consult your accountant to review your business’s cash flow, revenue or sales, and budgeting strategies. You may even need to examine your time management and organizational skills, too. All of these factors play a role in whether or not you’re capable of organizing, tracking, and paying off multiple forms of debt.
If you’re struggling or have struggled to manage multiple loans, then you may need to explore other options in the future or take caution before you apply for additional financing. At the very least, consolidating your debt is an opportunity to learn from your mistakes and figure out how to set your business up for success going forward.
Paige Smith is a Content Marketing Writer and Senior Contributing Writer at Funding Circle. She has a bachelor's degree in English Literature from Cal Poly San Luis Obispo, and specializes in writing about the intersection of business, finance, and tech. Paige has written for a number of B2B industry leaders, including fintech companies, small business lenders, and business credit resource sites.