While no one likes being stuck with debt, companies should expect to experience a level of it at some point in their lifespan. Setup costs and company expansion can temporarily put your account into the red, but it should soon go back into the black if the business is profitable. If a company is in substantial debt for a long period though, it can lead to more serious problems which could even spell the end of the company.
Growth Stops
Many companies seek opportunities to grow, and it can be very tempting to expand during busy periods. While temporarily increasing staff and resources to prevent your workforce from being overwhelmed may be a necessity, spending on extra staff or non-essentials when there’s not enough long-term revenue to cover them is a common mistake. Before expanding during busy periods, you should consider whether you can afford the extras during slumps. If the cost of these extras is unsustainable, they will ultimately hold your company back without the cash for future investment.
Decline Begins
As an extension of growth stopping, debt can also lead to companies being forced to make cutbacks. When this happens, if an arm or aspect of the business is deemed ‘unprofitable’ or ‘unessential’, it’s unlikely to survive the cuts. Depending on the company, these non-essentials could include staff, premises, suppliers, and even products or services that aren’t earning as much as your biggest money-makers. The company could shrink and may even have to reconsider its market.
Supplier Relationships Deteriorate
Imbalanced cash flow can cause a finance department to panic and withhold paying invoices to try and balance the books. Doing so, however, can sour relationships with suppliers and contractors, who could see you as unreliable. Deferring payments can lead to payees chasing your company for what they’re owed; this action could range from phone calls and letters from debt collection companies to a court order, such as a County Court Judgement (CCJ) in England and Wales, or even petition to force the company into compulsory liquidation. Even without the extra creditor pressure, your reputation could be damaged, and make other suppliers think twice about working with the company.
Credit Rating Falls
Actions associated with insolvency, such as; not paying your bills on time, switching bank accounts, refinancing regularly, and accumulating arrears will harm your credit rating. The health of your company’s credit rating is closely linked with the overall financial health of the company, and you should aim to keep it as high and healthy as possible. The lower the company’s credit rating, the less likely funders are to work with you, which can have a drastic effect on repayment terms, debentures and guarantees.
Effects On Directors’ Personal Lives
Severe business debt can impact a director’s personal life beyond the stress and anxiety of having an insolvent company. Limited companies have limited liability (hence the name), which protects the directors and their personal assets from creditor action against the company. However, if the company is insolvent, there are instances where directors’ personal finances could be affected by the company’s debt. Personal Guarantees, for example, often used to secure business funding and loans, can contain a clause that bypasses the limited liability. In a case of insolvency, this means the director may have to use their personal finances to repay the debt. If the company has an overdrawn director’s loan account, in which the director owes the company money, the director must repay it.
Summary
Having debt isn’t always indicative of financial trouble, but if a company doesn’t profit after its initial start-up period, it can be a sign of deeper issues. If unaddressed, company debt can lead to insolvency, growth grinding to a halt, and even lead the company to shrink. Although it can be tempting to defer payments to suppliers and contractors, doing so could harm relationships with both, and lead to your creditors acting to recover their debt. Your credit rating could also suffer, making it harder to secure funding going forwards. If you want your company to keep trading beyond the first two years, it’s important that you identify what’s causing any debts it may be suffering with and decide on a plan to alleviate them.
