How Businesses Can Avoid Debt Traps: A Practical Guide

Small businesses opt for debt solutions as they seem straightforward and convenient. They realise they have been caught in a debt trap only when they take on more debt to pay off the previous debt. 

• Minimise credit card debt

Credit card debt accumulated for businesses can be deceptive as it can suddenly turn into a large amount of debt. Also, interest charged on credit card loans can be in excess of 30% which adds up to large outstanding amounts. 

• Explore bill discounting

Bill discounting to create quick cashflows from sales also comes at a hefty cost. Bill discounting rates can range between 6% to 26% depending on the creditworthiness of the customer. You can engage in bill discounting provided you are willing to encash your sales at a discount. 

If you use capital equipment in your business, explore buying versus leasing if leasing is an optimal decision. But be aware that in leasing, you may be paying lease rentals in perpetuity without gaining ownership of the business. Plus, you also need to explore in detail the costs associated with leasing the equipment. Be particularly wary of hidden costs in leasing.

• Using L/Cs sparingly

Letters of credit can be a powerful tool to fund the business but can also become hidden debt traps. Use them sparingly only in times of great need and don’t fall into the trap of drawing on them continuously as this can create a debt trap.

Evaluate your financial circumstances thoroughly including all your sources of income and expenses, the total list of your business debts and the repayment outflows and structure a carefully planned financial forecast which smoothens the income and expense flows without the need for added debt.

• Negotiate with creditors

Negotiate with your creditors to reduce interest or extend the credit period. If you have large accumulated payables and you have a previous record of making prompt payments, negotiate with your creditors to lower the interest rates or accept extended credit periods without any penal interest.

• Combine your different debt instalments

Combining your EMIs on your debt payments into a single affordable payment. Consider using the services of a professional debt management agency like SingleDebt for Business to combine your various EMI payments into a single, affordable one.

• Use debt avalanche or debt snowball method

Apply methods like the debt avalanche method to pay the higher interest debt first before paying the installments on the lower interest ones. You can also consider using the debt snowball method to pay off lower interest debt to pare your debt slowly if your cashflows don’t permit a faster rate of payment.

• Pare unnecessary expenses.

Cut down on costs that are wasteful or do not add incremental value. Pare down costs which can also be postponed, like large equipment purchases etc. 

• Reduce outstanding debt

Try to cut down debt using the services of debt management services like SingleDebt for Business to reduce your debt repayment and interest outflows. While borrowing, avoid high interest debt and opt for low interest debt where possible. Monitor debt levels regularly and negotiate with your lenders where possible.

• Create an emergency fund

Create an emergency fund covering six-month outflows to provide quick liquidity where needed without resorting to debt. 

• Diversify revenue streams

See if revenue streams can be diversified to avoid relying on a single source of revenues.