While there can be many reasons to undertake a debt consolidation in your business, the single biggest reason, most of the time, is to improve cash flow.
And while cash flow can be constrained due to rapid and profitable growth, the majority of the time it is constrained by some down turn in the business or failure of the business to develop to a level of sustained profitability.
For these types of situations, here are some basic guidelines to consider before entering into a business financing debt consolidation action.
First, start the process as soon as you have consecutive months of cash flow deficits. Nothing about business financing is fast these days, so the more time you have to work through the problem, the more likely you’re going to end up with a workable outcome. And just because you started the process doesn’t mean that you’ll end up completing a consolidation action as things may change in your business for the positive before the process is completed.
Second, cash flow out your business for at least the next 6 months. If the ship is taking on water so to speak, at what point in time is monthly cash flow going to be positive again and how much money is going to be required to get you from here to there? For cash flow shortfalls, debt consolidation typically means refinancing existing debts that have fallen behind or are building up plus adding additional cash to the business to service the new loan until things turn around. There is no point getting a consolidation loan only to immediately fall into arrears with a new lender.
Third, factor in a higher cost of capital than what you’re already paying or not paying. Part of the cash flow exercise is to make sure that the go forward cash flow, post debt consolidation, is going to be positive. If the new cost of capital is significantly higher than what you were budgeting, your whole cash flow plan may go out the window.
There are two ways to do debt consolidation to improve cash flow. The first is to find a refinancing solution that will buy you more time and hope things work out before you run into cash flow problems again. The second way is to figure out a plan to get things corrected in the business and acquire incremental funds through refinancing to make the plan work plus some margin for error. In most cases, debt consolidation is a form of bridge financing that will allow you to get through a certain period of time of financial down turn. When things get better, you may choose to refinance again to accelerate debt pay down and/or acquire a cheaper source of financing.
While no plan is fool proof, having a plan is going to give you a better chance to improve the fortunes of the business and provide greater credibility in the eyes of lenders that are prepared to provide a debt consolidation loan in the first place.
The keys are to start early and be realistic of what the near future is going to look like. Being overly optimistic with respect to near term improvements in cash flow can lead to further problems.