Does the D-word make you feel that nervous knot in your stomach? You’re not alone—the idea of going into debt looms as a scary prospect for most of us.
But most small business owners need to take on some debt in order to grow their businesses. Too much debt is never good, but thoughtfully considered debt can boost your business, revving it into high gear.
So breathe deep, take heart and read on.
When you’ve got more work than you can handle.
Meet Stan. Stan had worked hard for 10 years—six long days a week, 10 or 12 hours a day—to build up his home repair business, and it was paying off. Business was flourishing, especially lately. Every day brought calls from potential customers who needed their repairs done before the cold weather set in.
He felt gratified and proud. He’d created his own business from scratch, and all that work had paid off.
But now he had a new problem: he had more work than he could handle. All he could do was take his callers’ names and add them to a waiting list, which he hated doing.
His worries were waking him up at night. Why was he spending good money on advertising? Homeowners were responding to his ads, but they needed their repairs now.
More than a few customers had gone to his competitors rather than twiddle their thumbs, waiting for him to call. He couldn’t blame them.
Stan knew the answer. If he was going to take on more clients and grow his business, he needed to buy a new service van, and he needed a crew to operate that van. But he just didn’t have enough money in the bank. It would take him two years, he figured, before he’d have enough saved up to pay for the van and its crew.
Save up, or take on debt?
As a kid, Stan had been warned time and again by his folks about the dangers of debt in both his personal and business lives, and he’d listened: borrowing money went against everything he’d been taught.
For weeks, he ran through the dilemma in his head: should he turn away new clients and wait two years until he had the cash to cover the van, or should he take out a loan to buy it now?
We’ll find out shortly what Stan did. But let’s look first at how he got there. (You’ll see some figures and the dreaded D-word below, but no cheating. If you skip to the end, you’ll miss the meat and potatoes, the part that allowed Stan, working with Turbo Execs, to come to his final decision.)
Three simple questions to ask yourself.
1. What’s it really going to cost?
When thinking about a major purchase or expense, make sure to take a good look at all of the costs.
In Stan’s case, his new truck was going to cost him about $45,000. But there was also the 5% interest on his loan. He knew that the length of a vehicle loan could vary from 36 to 72 months and that the longer the term of the loan, the lower the monthly payment. Low monthly payments: he liked the sound of that.
But Stan also needed to consider maintenance for the truck, the cost of paying its crew and employee-related costs (health care, Social Security and taxes). Bummer. Those were a lot of costs to consider, and Stan’s estimate for these other costs came to $2,500 per month…more than he’d expected.
2. How long will it last?
Does your new purchase or expense have a lifespan? No one can reliably predict the future (wouldn’t that be great?), but most things—new equipment, for example—don’t last forever.
Now that he had the numbers, Stan needed to think about how long his truck would be in service. How many years could he work the truck—and he knew he’d be working it hard—before things started to need repair?
Five years, he decided, was a realistic estimate. He knew it wouldn’t make sense to finance the truck for longer than that.
Stan estimated the overall operating cost for the truck at $2,500 per month. That’s what the loan, vehicle insurance, additional employee, gas and other supplies came to.
3. How much more money will I earn?
Once you’ve added up the cost side (and taken another deep breath), it’s time for the fun part: calculate how much more cash your new purchase will allow you to earn!
Your figure for your sales monthly goal—Stan’s was $5,000—will give you the amount of profit you’ll need to earn each month to break even on your new investment.
In Stan’s case, he needed to earn $5,000 a month to break even. If he earned $6,000 to $10,000 a month (at his gross profit rate of 50%), he’d actually be making enough to put $3,000 to $5,000 in the bank every month.
Could he do it? He was already bringing in $15,000 a month, so he knew he had that going for him. A new truck and added crew would let him take on the jobs of those customers already on his waiting list and to add many more new customers. And if he did only 10 more jobs, he’d earn an additional $6,000 to $10,000 a month. He felt better already.
Ask yourself if you have potential jobs already in the pipeline. Sit down and make a list of them—you probably have more than you think. Now put yourself in your customers’ shoes, and ask how long you’d be willing to wait for service. Two weeks? Three? If you’re looking at longer than three weeks, the answer should be pretty clear: not having that new piece of equipment is costing you a potential windfall of cash.
If you don’t have potential clients lined up, ask yourself how you can make that happen. Do you need to follow up with previous customers for more work? Is it time to think about fresh marketing techniques, including kicking up your presence online?
Will I get my loan?
So how does the bank decide you’re a good risk? Let’s peek behind the bank’s curtain (okay, really thick doors) for a moment. If you understand how loan officers think, you’ll have a better idea about your chances of getting a loan.
The loan officer has a lot of fancy phrases (“debt-to-asset ratio,” for one), but basically he or she looks at your business’s total assets, your ability to generate enough cash to pay back your loan and how much risk you’re willing to share with the bank.
What You’re Worth. The loan officer looks first at your business’s total assets. In Stan’s case, for example, that would include any money in his business’s bank accounts, the workshop and office he owns and the two trucks he has already. He compares this to the amount you want to borrow to get your “debt-to-asset ratio,” which is a measure of how much your company relies on debt to finance its assets.
How Much Money Can You Make? Now the loan officer looks at your business’s ability to generate enough cash to cover your loan payments. He calls this the “debt service coverage ratio” and calculates it by dividing your net operating income by your total debt. Any ratio higher than 1 is considered a good risk for the bank.
What’s Your Skin in the Game? The loan officer is now ready to look at how much you’re willing to put on the line to make your loan happen. The officer calls this the “loan-to-value,” or LTV, ratio. In English, this means dividing the borrower’s loan amount by the value of the asset.
Can I learn to love my loan?
One of the biggest benefits of borrowing money is that you’re leveraging someone else’s money to grow your business. Instead of having a lot of your available cash eaten up by a new purchase, you can use it to grow your business. That’s a big upside.
So, what did Stan do?
He decided to buy the truck and finance it for 36 months. With his new purchase, he was able to bring in an additional $7,500 a month in income, which covered his operating costs, put money in the bank and made him full owner of the truck in just three years, two years ahead of schedule—and long before anything needed repair. Mission accomplished, and then some.
Go for it!
Do you need help deciding whether taking on some debt is the right next step for you?
Patty Lawrence of Turbo Execs has helped scores of small business owners make this decision and has taken the fear factor out of the equation. Patty has found that the willingness to risk a reasonable amount of debt has helped her clients propel their businesses into the fast lane—without losing a sense of financial security.
If you’re unsure about taking that next step, let us help. Get in touch with Patty today.