Its hard to look at the news these days and not hear or read about someone in a debt crisis, whether it be an individual, business, or country.
A debt crisis typically occurs when there is more money going out than going in and debt is used to fill the gap or hole in the cash flow.
Debt is acquired by leveraging assets on the balance sheet.
In order for any business to be able to access business financing debt and/or not get their existing debt called, they have to manage their balance sheet so that it meets the requirements of the lender.
In times of recession and down turn this can be extremely difficult, especially for new businesses.
But for existing businesses, governments, and countries, how many debt crisis scenarios could be avoided if better balance sheet management was being practiced?
By keeping the balance sheet in order (working capital ratio greater than 1, debt to equity ratio less than 5, all debt payments up to date, etc.) the business retains its ability to borrow money for times of growth and times of distress.
In good times, debt needs to be paid down, and in bad times debt may need to be required to keep the business going until the economic forces change back in favor of making profits.
But if a business is always living too close to the edge, good times or bad, there is no margin for error, and this is when a debt crisis occurs.
Proper planning and proactive management of the balance sheet will not guarantee that your business will never fail or reach a debt crisis moment.
But it will increase the probability that you will survive unexpected economic events by providing you with the means to finance yourself out of problems to a certain degree.
And if you do fall into this type of debt financing need, its going to be important to pay back the debt and build up your buffer for future needs.
While this may all seem totally elementary, building debt is an easy trap to fall into.
When things are going well in the economy, lenders will bend over backwards to give you access to more debt, even if it works against the fundamental balance sheet principals you should be managing.
And when there is a down turn, there is little forgiveness for those that are over extended as they are typically the first casualties.
The fundamentals are always the fundamentals.
Sometimes you have to say no to an opportunity if its going to overextend you too far for too long of a period of time.
Some times you have to retreat and try to minimize the damage when things are going against you versus throwing good money after bad.
By keeping your balance sheet in order, you will always have better options to consider than if you don’t.
And if you plan to stay in business for a long period of time, the ups and downs are going to be inevitable, so maintaining a strong borrowing basis is not really an option, its a requirement, unless you like walking a financial tight rope every once in awhile.