Why Debt Consolidation Might Not Be The Best Solution for Business Cash Flow Problems

A small business often gets stuck for want of working capital, and the easy way out during such situations is to get a business loan. There was a time when applying for business loans involved lengthy processes, countless paperwork, and many questions, but today, any bank is more than willing to provide a small business loan very quickly and on submission of minimal documents. When a business starts to take such small loans one after the other, the debts start to pile up, with each line of credit having different payment schedules and amounts. The business owner can find it difficult to track the payment dates and sums of so many loans, and that is when they go in for debt consolidation.

What is debt consolidation?

A debt consolidation loan is one that is given to replace or take over several smaller business loans. It is expected that the business owner would be able to negotiate a better rate of interest, and only worry about that one loan instead of having to manage multiple lines of credit. The expectation is also that it will lead to an improvement in credit rating. However, these benefits might overshadow certain disadvantages as well. Let us see a few scenarios in which debt consolidation might not cure cash flow problems for business.

Lower rate vs. longer tenure

The most significant attraction of a debt consolidation loan is that it carries a significantly lower rate of interest. While that is true for most debt consolidation loans, the reality is that most such loans do not offer lower interest. They only extend the tenure, which gives a perception of an artificially lowered rate. It will not cure the cash flow problems of business because the loan repayment amounts per month or quarter would reduce but the repayments would need to be carried on for a more extended period. That means the strain on running capital would continue for a long time.

Assets at risk

It is almost a given that a debt consolidation loan would involve security to be submitted as collateral. That is fine as long as the dues get paid on time, but if there is a default, the asset stands at risk of being taken away for sale by the creditor.

Old habits die hard

A firm going in for a debt consolidation loan would have likely gone into that situation because of the unhealthy practice of taking loans, for which repayment capacity was not adequate. If a single consolidated loan replaces those, then it might offer temporary relief, but if the earlier bad habits continue, then the only line of credit could also start creating problems, and the company would soon be back to square one. We spoke to a portfolio manager at National Debt Relief sites who opined that taking loans was a seemingly easy way out for working capital shortages, but could have an adverse impact if allowed to become a habit.

So, is there any way that a business can become totally debt free and not require a debt consolidation loan at all? Even if it does, is there a way to close that loan quickly and keep the company running without debt? Let us examine some simple ways in which any business can achieve that goal.

Every company does not need loans

It is a myth that every company needs to borrow money to survive and flourish. It has been drilled into our brains by all the banks and financial institutions that wish to increase their loan portfolio. However, every business owner must realize that if he/she borrowed $10, the amount will gather interest and become $12 by the time he/she pays it back. So, the business would need to be making more profit than the interest payout to keep that loan sustainable, while helping the company grow its profits. A much better idea for a business is to cut necessary expenses where possible, defray non-essential costs, and revisit the credit lines provided to vendors as well as clients. Let us look at each of these.

Non-essential expenses

There are expenses that a company does not need to have immediately and can be postponed to the next financial year. For example, if it is a company that produces earphones or Speakers, and they plan to post an ad on a music website, they could wait for a more suitable period rather than rush into it.

Credit terms

A company has to deal with credit on two fronts. One is the credit it gets from its suppliers, and the other is the credit it has to give to its customers. On both fronts, a company can renegotiate terms in its favor. The longer credit received from creditors, and the shorter credit given to buyers can leave the company with more cash in hand every week and every month, and maybe a costly loan can be avoided this way.

Reduction of expenses

Even expenses which cannot be postponed can be reduced to a certain extent by a careful examination of available options. For example, a company can call for further quotations for stationary, and try to get a better quote without compromising on the quality.

Can debt consolidation cure cash flow problems for business?

As we saw above, a debt consolidation loan might seem like the perfect solution for a company which is struggling with cash flow. However, the owner must realize that debt consolidation is not writing off of a loan, only remodeling the same. Even if it offers better terms than the earlier loans, it still does not make a company debt free, and a portion of its profits would go towards servicing the interest component of the credit. A much better idea for a company is to take focused steps to ensure that loans are not needed at all, and if they are needed, they are obtained only when necessary. Also, the borrowed sum needs to be paid back on time to avoid penalties and additional charges.