Five keys to profitability: Part 3

Click here to read Part 1 and 2 of this series.

 

Low Debt

In 1991, Danny Devito touted “other people’s money” as the means to get rich. He meant levering other people’s money – which is your debt – into a profit opportunity. Using bank money is especially attractive right now because debt is cheap – the interest rates are low.

But there is snake in the heart of this argument.

No company with which I have ever worked has thrived with high debt loads. High debt load cripples the company’s capacity to be nimble in the marketplace, raises the fixed costs that have to be met every month regardless of sales. Debt makes the business worth less money.

Out of every recession, some companies emerge with a stronger market position and weakened competition. These companies are in the driver’s seat to crush the competition or to buy their competitors at rock bottom prices. Why? These companies have little debt and piles of cash on hand! With small amounts of debt it is simpler to find the funds to buy a competitor, or the machinery that will eat the competition alive. With small debts, you can easily buy that important order, get deals on supplies, or hijack the best sales people. In a recession nimble companies eat their competitors’ lunch.

With high debt loads, the fixed costs are raised considerably. If your profits before tax are 10% and your debt payments are $10,000 per month, you must find $100,000 in extra sales just to pay the debt servicing charges. And this is every month regardless of business cycles or collection of funds.

Every dollar of debt must be met with an extra dollar of asset value to keep an even keel. Extra debt without a commensurate increase in assets (cash, equipment, land) reduces the real value of the company, its borrowing power and ultimately the sale price.

Debt is cheap right now due to low interest rates. But, business owners and individuals have taken their eye off reducing that debt. With debt cheap, it should possible to pay down debt more quickly and put the company into a stronger industry position.

Finally, think of the cash flow. If your company did not have to find that $10,000 per month to finance its debt, what would you do with that extra cash? Nice daydream, isn’t it?

 

Written by Andrew Gregson, Senior Partner at Floodlight Business Solutions and author of Pricing Strategies for Small Business (2008). 1-888-959-0752 www.floodlight.ca. Floodlight Business Solutions, where we help you drive profits.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.