Five key debt questions you need to ask yourself

3. What are the disadvantages?

Using debt comes with some risk.  The bank will take security over the assets of the business and possibly the personal assets of its directors.

If you default against the loan, the penalties can be hefty in terms of higher interest rates and additional fees.

In a worst case scenario, the bank can call in the loan, appoint a receiver and seek to sell the business and its assets to recoup their funds.

Banks will also set covenants such as interest rate cover, profitability and level of owner drawings. They will also require you provide financial reports to demonstrate you continue to meet these covenants.

So while the banks don’t own any equity, they can still exert control over the business through their security and the performance covenants they impose.

4. How much debt should I enter into?

How much actual debt you incur will depend on the ability of the business to meet the repayments. To work this out, businesses should prepare a cash flow forecast.

When setting the forecast, you obviously don’t want all surplus cash going towards repaying the debt. So you need to factor in a comfortable margin and allow for any variability in your cash flow from month to month.

By taking this a step further, you can improve your position by analysing your cash to cash cycle.

Identify ways to make your cash work more efficiently for you, improving its speed of movement through the cycle and therefore bringing more cash into the business, which can be used to pay down your debts sooner.

5. What should I do before I borrow?

Before you borrow, one of the most important things you should do is get financially organised. There are some basic financial management disciplines that you should put in place. These include:

• Preparing a cash flow forecast.
• Understanding the current financial position of the business and its cash to cash cycle.
• Implementing a management reporting process to allow you to track your financial performance and to enable timely reporting to the bank.
• Assessing whether the cash return on the proposed investment will be greater than the principal, the interest repayments of the loan and what the cash flow breakeven point is.
• Evaluating whether the business will be able to meet the performance covenants that may be imposed by the bank

If your assessment indicates that you should not take on additional debt, don’t despair. An expert review of your financial and cash flow position can often uncover opportunities to better utilize cash within the business.

The alternative is to also evaluate and develop a grants strategy to tap into the 650 grants available that are assessed on different financial and business performance measures.

Marc Peskett is a director of MPR Group a Melbourne based business that provides finance lending, grants advisory and capital raising services as well as business advisory, tax, outsourced accounting, and wealth management to fast growing small to medium enterprises.  MPR Group is a member of the Proactive Accountants Network. 

You can follow Marc on Twitter @mpeskett