Debt Management: How Companies Handle Borrowing

Borrowing money in business is not a sign of weakness, but it’s a strategic move a business took. Startups can borrow money to finance their pre-operating expenses. Established businesses borrow money to fund their growth and expansion and support their working capital. Many companies fail to pay borrowed money, resulting in liquidation and, hence, closing up. Loans are an effective tool when they are used wisely by implementing various debt management techniques; this is what companies that are operating in debt do. In the article, we will dive into debt management techniques, why a business needs borrowing, how a business can handle debt, and the consequences of poor debt management.

Understanding Debts and Debt Management

Debt is money that a company acquires from external sources. It is later paid back with interest and principal. Debt can take various forms, such as loans, debentures, corporate financing, mortgages, and credit cards.

Debt management- According to True Tamplin (2023), it is the process of planning, coordinating, and repaying debt in a way that minimizes the financial risk of the organization and helps it meet its economic objectives. This involves a financial manager examining the financial obligation status of the business, coming up with a plan on how the borrowed money will be paid, and enforcing tactics that prevent the company from debt challenges In the future.

Why Does a Company Borrow Money?

The research done by Annabel Ah-Lim (2024) highlights that businesses borrow money due to the following reasons.

Expanding business operations– any business operates with the objective of making a profit and expanding. An opportunity for expansion can come, but a business may find that it does not have enough funds to invest in the new opportunity. In these circumstances, a business borrows money to fund its increased production, venturing into new markets and creating new branches for the business. This enables a business to take opportunities faster instead of waiting until it raises enough capital.
Purchasing equipment and stock. A startup business needs to buy equipment that will help in day-to-day activities. An established business will also need to replace old assets when they become outdated. In this case, a company can acquire loans to buy a particular asset. Additionally, a business can agree with its suppliers to buy stock on credit, sell the goods, and then pay back the money to the supplier.
To finance innovations, a business must borrow to support them. Innovation is crucial for a business because there is a lot of competition in today’s business. For innovation to be effective, any organization needs proper research and development, which requires a company to invest a lot of money.
Boost the working capital- working capital is the amount of money that a business needs to finance its day-to-day activities to ensure that the business is running smoothly. During economic downturns, a company may be experiencing low revenue; thus, the amount of working capital available in the business is low. The business then is forced to borrow money to boost its day-to-day obligations like paying its creditors, salary payments, and utilities.

Debt Management Strategies for Companies

Research done by Sanjay Bulaki Borad highlights the strategies that a company can take to manage its debt:

Diversification of revenue streams– The business uses its revenue to repay borrowed funds, which requires the company’s revenues to be stable. For the business to have a stable revenue, it needs to spread its revenue streams to different products so as to reduce the dependence on one revenue stream so that during economic downturns, if one revenue stream fails to provide revenue, the other one will be producing income. For instance, a tech company can spread its revenue streams into developing software, selling tech products, and offering consultations. This business has a better opportunity to pay its loans because if one revenue stream fails to produce revenue, others will be creating revenue.
Optimization of cash flows—a business that is able to meet its debt obligations when they fall due needs reliable cash flows over time. For an enterprise to achieve this, it needs to ensure that its cash inflows and outflows are efficiently managed by monitoring and collecting debts on time. Additionally, the business’s expenses are controlled. This ensures that the business gains maximum cash flows from its operations, which it uses to pay its loans.
Evaluating financial health—A business needs to assess itself through methods like conducting audits and analyzing financial statements. This will help a company understand its economic health, thus helping decision-makers decide whether to take on more debt and adjust their repayment strategies. It can also help a business spot the symptoms of bankruptcy earlier, therefore avoiding more debt.
Strategic use of debt—Debt is an instrument; if used well and optimized, it can result in business success. Many successful companies usually borrow when necessary, like when they want to fund expansions or buy equipment. These investments later lead to cash inflows, which help repay the borrowed funds. Strategic use of debt avoids unnecessary borrowing, which increases a business’s financial risk.
A financial advisor—A business dealing with a lot of debt capital and cash flow problems can find debt management challenging. That is why a business needs to look for a financial advisor to help them navigate these challenges. The financial advisor can help the business design repayment strategies, re-negotiate the loan conditions, and advise them on circumstances in which they may need to borrow.
Reducing non-essential costs—Another way of managing debt is to cut unnecessary expenses. When a business reduces unnecessary costs, it can make more profit from its revenue, which is then used to pay the loan, thus managing the expenses.
Creating a budget. A realistic budget will guide a business in managing its expenses. In this way, a business can locate its funds on all of its operations, like debt payment, operations, and growth. This helps a business ensure that debt obligations are met and that it is not overspending.

Risks of Poor Debt Management

High financial costs—When a business does not manage its debt carefully, interest payments can accumulate over time. This will cause the business to spend almost all of its earnings to pay the interest, hindering the business’s growth and smooth operations.
Poor credit history—Poor debt management leads to loan defaults, leading to a bad credit score and credit history for a business. This reputation makes it difficult for a company to acquire loans in the future because lenders will access a business’s credit history before giving a loan, making it hard for a business to access loans, or even if given a loan, it will be at high interest rates.
Legal consequences—When a business is unable to pay its debt for a long time, the creditors will go to court, and legal actions will be taken against the business. The court will give the creditor power to repossess the business’ assets, leading to the winding up of the business.
Instability and financial stress—Poor debt management can cause a business to be unable to pay its borrowed funds. This creates financial stress for the business’s owners and employees, which in turn hinders productivity, damages relations with suppliers, and leads to high employee turnover as employees feel their jobs are at risk.

Conclusion

Debt is a tool; when used correctly, it leads to the growth of the business; on the other hand, it can lead to serious problems when it is not managed well. A business can borrow money to fund its operations, buy equipment and stock, boost working capital, and invest in innovations; after Acquiring the loan, a business needs to employ debt management techniques like cash flow optimization, diversification of revenue streams, cutting unnecessary expenses, having a realistic budget, and seeking advice from a financial advisor. Failure to manage debt in a business can cause challenges like disclosure, poor credit history, high economic cost, and financial stress; hence, a business needs to acquire borrowed funds when necessary and apply the debt management strategies above to avoid the negative consequences.