Strengthening Small Businesses: Responsible Financial Management and Debt

UPDATED AUGUST 10, 2022

Small businesses are essential to the American economy and their contributions to innovation and employment in high tech industries, like computer systems design, architecture and engineering, as well as in high-patenting manufacturing industries, are significant. In 2021, for example, small businesses made up 99.9% of all firms and 99.7% of all paid employees, even though 81% of all small businesses had no employees according to the U.S. Small Business Administration’s (SBA’s) statistics. In 2019, firms employing fewer than 20 employees experienced the largest gains, adding 1.1 million net jobs. And the industries with the highest share of small business employment in 2017 included agriculture, forestry, and fishing and hunting; other services (except public administration); construction; and real estate and rental and leasing.

Considering the range of small businesses and the economic contribution they make, small businesses are an excellent value and hit well above their size. But not all small businesses make it. From 1994-2019, an average of 67.6% of new small businesses survived at least two years, while 48.9% survived five years. One-third persevere for ten or more years. And business survival is only one part of the story since the number of startup businesses (small and large) have exceeded closures since 2012, a positive trend worth strengthening.

SBA advises small business owners to “earn the right to borrow” by first investing your own money in your company. This shows you are committed (“have skin in the game”) and demonstrates you have the skills necessary to run a successful business. For business expansion, SBA says common sources of capital for small firms come from personal and family savings (21.9% of small businesses), profit and assets (5.7%), business loans from financial institutions (4.5%), and business credit cards from banks (3.3%). When taking on debt to obtain capital, some small businesses get into difficulty by overextending themselves, which can lead to failure. If your small business has excessive debt, you must take immediate corrective action. Failure to act can lead to a downward cycle ending with the closure of your business, or worse, pulling you into bankruptcy, which not only destroys your business, it also can ruin your personal credit and assets.

Step One – Take Command of Your Finances.

Examine your financial statements to understand what type of net income you are bringing in each year and how your expenses may be increasing. If financial statements scare you or make your eyes glaze over, get over it and get help if needed from local and online credible sources, such as SBA’s Learning Center and Small Business Development Centers (SBDCs), or SCORE. All offer courses (online, Webinars, and in person) and mentoring on all aspects of your business development, including financial statements.

Study your balance sheet to assess your company’s assets (liabilities + owner’s equity = assets). Both sides must balance. Assets include current assets (cash, inventory, prepaid expenses, accounts receivable) that you can convert to cash within one year, and fixed assets (such as land, buildings, furniture, equipment).  Liabilities include short-term liabilities, such as accounts payable and taxes, and long-term debt. Owner’s equity includes any invested capital and retained earnings.

Study your profit and loss statement (also called an income statement) to analyze your projected sales and expenses over the next few months to one year.

Study your cash flow statement, which includes cash inflows (sales, accounts receivable, loans and other investments) and cash outflows (equipment bought, expenses paid, inventory and other payments).

Evaluate how can you generate more revenue. Who owes you money? How can you accelerate collection of payments due you? How much cash do you have left after salaries and expenses are paid? Where can you cut? If necessary, what assets do you have that could be sold to pay off some debt?

Know where you stand financially and assess what steps you can take to help reduce your debt.

Step Two – Complete a Budget

Take the time to put together a budget. How much income do you anticipate in the coming months and years? What expenses do you see in the near and distant future? How much profit do you realistically expect to make each month? How much do you anticipate spending on loan repayments? Once you have an idea of what the future holds, you can begin planning how much money you can dedicate to debt reduction versus ongoing operations and growth.

Step Three – Create an Emergency Fund

While you are struggling to reduce your business debt, you may wonder how you would be able to create an emergency fund for your business, but this is a good time to start building your economic resilience. Sometimes things happen that are beyond your control and expensive to recover from, such as a fire in your building, a power outage that ruins frozen inventory, water that damages equipment or supplies. Whatever the emergency, you need to be prepared. Start small and be realistic. An emergency fund can help your business survive through difficult times without incurring more debt that could put you further behind.

Step Four – Negotiate with Creditors

Talk to your creditors about refinancing options to manage your debt, such as reducing interest rates. You may also qualify for an SBA loan, or even a hardship plan. Unsecured debt holders, like credit card companies, will often work with you or a business credit counselor to reduce debt. Contact the vendor with whom you have outstanding invoices and set-up a repayment plan. These efforts will help you budget for the upcoming months and make your debt reduction plan more feasible.

Step Five – Pay Debt…Then Save

Businesses faced with large debt can reduce their obligations through the following options: make regular payments on your debt, make higher payments, reduce expenses and allocate that money to debt repayment, pay off small debts first and work your way up to the largest debts (Debt Snowball Method) or start with those loans that have the highest interest rates (Stack Method). By reducing your debt, you are lowering your interest expenses and reducing financial stress on the business and you. Once these major expenses are off the books, you can then use those monthly payments to save for needed expenditures (such as new equipment, hiring more staff, etc.).

Managing your business’s finances and debt responsibly will strengthen your business and position it to thrive and grow.