ADVANTAGES OF A DEBT-FREE BUSINESS

Venture capital, business loans, and lines of credit: all this and more exists for businesses that need to grow, to purchase equipment and inventory, or expand their facilities. Much of the initial growth for small businesses is funded on borrowed money. But this leverage comes at a very high cost.

In the last few years, businesses have begun to move away from acquiring additional business debt either by choice or by circumstance. The tightening of credit, loss of access to capital, and the general tightening among potential investors, bankers and lenders have made the prospect of boot-strapping a business a much more attractive option. Sometimes it is the only viable option.

But is running and growing a debt-free business practical? What are the downsides? And more importantly, what are the advantages of building a business without borrowed money?

Starting From Scratch Or Changing Course

Financing a new business without borrowed money is challenging and it takes time. This is probably the first reality an entrepreneur has to come to grips with if you choose this route: you have to start relatively small and be prepared to take a longer period of time to reach your goals.

Another downside is the potential for seeing competitors gain market-share and grow revenues much more quickly as they take on borrowed capital to fund their capital acquisitions, marketing and production projects.  But be patient, the tables will turn down the road, and in the meantime avoid discouragement and second thoughts about maintaining a debt-free strategy.

Traditionally, businesses that use debt from borrowed capital have a completely different set of challenges when making the move to become debt-free.  For one thing, the business owner must be intimately familiar with the company’s finances. You will need to know exactly where the money goes and the business’ real profitability at all times in the business operations. The business must operate using an operations budget, and another strategic tool is a comprehensive cash flow management plan. Diligence is required as well as a total rethinking of “how we do business” if the company is going to decrease expenditures, increase cash flow and pay off the existing debt.

While business owners may find this to be an intimidating prospect, evidence proves that during economic downturns the less debt a business holds, the greater the odds of the business surviving. And when the economy is looking much brighter, the debt-free business is in the strongest position to leverage their advantages and seize many opportunities.

It's Possible

A few years ago, an investor noticed that among a relatively random selection of stocks from high-debt companies the average year-to-date return was -6.9%. An equally random selection of debt-free companies tallied up an average return of +18%. While this was not a scientific study by any means, it does serve to illustrate the fact that companies without debt can be more profitable than those carrying a significant debt load.

One company operated from a no-debt perspective since going into business over ten years ago.  More recently, he began to diligently and consistently reinvest a portion of his monthly earnings into a “cash reserve” fund with the goal of having at least a year’s worth of operating capital liquid and available. This fund served him well during the recent economic downturn when he needed to invest in added staff and equipment in order to take advantage of new opportunities that he would not have been capable of taking on at his previous size.

His competitors, on the other hand, were in the middle of downsizing and cost-cutting while still servicing the debt they had incurred during the previous “boom” years. As their overall profitability declined so did their flexibility – they were not in a position to compete for the opportunities this business owner was able to secure for his own company.

Another tactic that has served him well is to maintain a “cash-only” policy with his customers. While he does require one-half payment on acceptance of a project and the second half upon completion, this arrangement allows him to operate in a positive cash flow throughout the duration of the projects. Furthermore, he can offer his clients a slightly lower fee since he does not have to finance receivables for 30 or 45 days like his competitors do.

The upside of all this is that business owners who are operating without business debt have a greater degree of financial freedom and flexibility, and a much lower degree of risk in the face of economic downturns and declines in business.

Sacrificing the Fast Track for Slow Growth

For the majority of businesses that opt for a debt-free model, business growth tends to be slow. Jay Steinfeld, CEO of Blinds.com, made it a point to get – and stay – debt-free. “It’s been our goal to grow inch by inch, never spending beyond our means,” Steinfeld said. “We’ve done it all debt-free!”

While it is true that borrowing capital enables a business to take actions or grow at a pace that would not be sustainable otherwise, it also causes that business to be less flexible and incur higher risk. The more the business borrows, the more it spends towards repayment of debt and interest– cash flow is directly impacted as well as net profit. It is a sobering reality that many companies have failed from the lack of cash and cash flow more than anything else.

Five Points to Consider

Becoming a debt-free business, or building one from the ground up, is a lengthy process. But there are some strategic points that must be embraced if you want to succeed:

1.     You need to know the true cost of delivering your service or product.

2.     Become crystal clear as to where the money goes and the money comes from– in other words your Cash Flow.

3.     Develop and use an operating budget, and cash flow budget as a daily decision making tool.

4.     Daily, know your KPI’s (Key Performance Indicators) for your financial condition– like cash, accounts receivable, and accounts payable. Operate your business with this knowledge in mind.

 

5.  Consistently measure revenue, gross profit, and cash.

 

Conclusion:

 

While there are no guarantees in life, it is certain that as a business owner you will sleep better at night knowing that your business is stronger and more secure in these uncertain times as a debt-free operation.  Furthermore, with a secure cash position in the business, when opportunity knocks you are able to quickly pull the trigger on an acquisition or opportunity.