As a business owner, you’re constantly navigating through a myriad of challenges and opportunities, each carrying the potential to shape your future. One of the most critical components of this journey is understanding your current financial position and envisioning where you want to be, especially at the end of your business life. Are you striving to retire comfortably, embracing the lifestyle you’ve always imagined? Or is your ultimate goal to build a lasting legacy that transcends generations? Whatever your vision, managing and reducing business and personal debt effectively plays a pivotal role in bridging the gap between your present circumstances and your desired future. We’d like to offer a strategic approach to tackle business debt, guiding you towards your envisioned future.
This approach centres around 5 key steps, but everything needs to start at the beginning.
Work Out How Much You Owe
Understanding your financial position is the crucial first step. The initial question to answer is, “How much do I owe?” The answer will provide a clear view of your total liabilities. This process involves taking inventory of all your loans, credit card debts, outstanding invoices, and any other obligations.
It’s also essential to determine whether your debt is tax-deductible or not. For instance, interest paid on loans used for business activities is often tax-deductible. However, specifics may vary depending on the tax law. Having an accurate understanding of your tax-deductible debts can help you make informed decisions about which debts to pay off first.
Understand Your Surplus Profit
Your surplus profit is the money left over after all necessary expenses have been met. It’s the amount you can contribute toward paying down your debts.
To calculate your surplus profit, subtract your total expenses from your total income. Keep in mind that your net profit might fluctuate from month to month if your business has seasonal peaks and troughs. Therefore, review these calculations regularly to maintain a realistic view of your financial position.
Prioritize Your Surplus Cash Flow
Once you’ve identified your surplus profit, the next step is to prioritize what to do with this cash. While it might be tempting to invest in business growth or distribute it as owner’s profits, a more prudent approach could be to focus on reducing debt, if this is in alignment with your current financial goals.
Reducing debt has the advantages of:
- minimising your financial risk as less exposure to interest rate rises and reduced compulsory loan repayments; and
- it frees up more cash in the future, as less money will be needed for interest payments and principal repayments.
This could lead to more significant opportunities for investment or profit distribution down the line.
Identify Which Debts to Pay Off First
A common strategy for debt reduction is to pay off non-deductible debts first. These are typically the ones with the highest interest rates. This approach, known as the ‘avalanche method,’ can save you a significant amount in interest payments over time.
Start by listing all your debts, their interest rates, and whether they’re tax-deductible or not. Then, begin to pay off your non-deductible debts, starting with the one with the highest interest rate.
Seek Professional Help
Navigating the complex world of business debt management and reduction can be overwhelming. That’s where professional accounting firms like the team at DFK Everalls come in. We can provide tailored advice based on your unique financial situation, that starts with understanding what your goals are, where you see the end point for your personal circumstances. We can help you create a debt reduction plan and make strategic decisions about debt repayment including minimising your non-deductible debt.
We can also help you make sure that you have the right finance for the right purpose, with the right security, thereby ensuring that you don’t pay a higher rate of interest than necessary; that you don’t have loans dragging on for assets that you don’t own anymore; and that you use and/or preserve your security for the right purposes.
Debt reduction is just one part of the journey towards financial freedom. Our expertise could prove invaluable in reducing your debt. Building good financial habits can help maintain your financial health in the long run. This includes creating and sticking to a budget, setting clear financial goals, and regularly reviewing and adjusting your financial plans as necessary.
We’d love to be with you on that journey, so if you’re ready to have a discussion around debt reduction (especially in a time of rising interest rates), let’s start the conversation.