Updated on 24/06/2020
For small to medium-sized businesses, changing market conditions, economic uncertainty and evolving consumer needs can have a huge impact on your finances. When this happens, it's sometimes necessary for businesses to revisit and update their existing debt agreements to give themselves a little more breathing room.
That’s what business debt consolidation is all about. By swapping out existing debts or consolidating multiple outstanding loans into one secured or unsecured business loan, businesses can renegotiate parts of their contract to secure a new loan deal that may better meet their individual needs.
There are many reasons a business may want to consolidate their debts, here are some of the best-known motives:
Lowering your interest rates is one of the most common reasons for debt consolidation. If, for example, you have five outstanding business loans from different lenders, and an average interest rate of 8% across those loans - it could benefit your business to consolidate the outstanding loans down to one single loan from a new lender which is able to bring the interest rate down to 5% for you. That said, these figures are arbitrary and it’s worth doing your own research to find out what rates are available to you.
If a lender, such as a bank, can afford to buy outstanding debt that a borrower, such as a small business, has and pay off the entire sum of the debt at once, the debt is considered paid and whatever interest rates payments were agreed upon therefore no longer apply.
The bank can then set their own interest rate to charge to the small business, providing it agrees to the proposed terms and conditions. By offering you, the small business owner, a lower interest rate than you’re currently paying, they can provide you with value and, in exchange, acquire your interest payments. So, the 8% interest rate you were paying on your previous debts could be replaced through consolidation, with your new lender providing you with a lower rate and potentially being a more attractive option for your interest payments.
So, business debt consolidation can be good for lenders - but it can also simplify the repayment process for borrowers. Your accountant (if you have one) may find themselves only having to track and monitor repayments on a single loan rather than on multiple, which means they may have less to worry about.
Moreover, any admin work that facilitated the payment of various outstanding loans would be greatly reduced by consolidation. This could free up plenty of extra time and resource to be reallocated in a way that can better benefit the business.
One reason a borrower may turn to debt consolidation is because they need a lower interest rate on their outstanding debts to be able to afford the loan repayments. Having that lower interest rate could protect their credit score by helping them to avoid the alternatives to consolidation. These alternatives could include bankruptcy or debt settlements- both of which could negatively impact a business’ credit score; potentially making it harder for them to borrow in the future.
What’s more; consolidating business debts that are credit based and fluctuate or vary month-to-month into one single loan repayment could yield some benefits. Typically, consolidation loans do involve making fixed repayments amounts over a fixed amount of time - and having that predictability and structure within your repayment schedule could really help a business control and monitor their finances; making forecasting and planning ahead a little easier.
It’s important to note that there are potential risks associated with business debt consolidation. When a business consolidates various outstanding debts into a single loan repayment which is fixed, and pays the minimum amount on that each month, the chances are that they’ve obtained better lending terms and conditions from their new lender. But, if the old accounts from previous debts (e.g. credit cards) are not closed, it could be tempting to make purchases on those accounts not long after they’ve been cleared.
Before you know it, you could find that your debts start building up again and compounding; creating more problems than you originally had. One way to help to avoid this is to have a detailed financial plan laid out for the coming financial year – so that you can remind yourself of your long-term goals and objectives, and possibly even prevent yourself from making any rash or impulsive financial decisions.
Something to also remember is that taking on any new debt is a big decision; extending the term of your debt can incur more interest and cost more in the long run and sometimes an early repayment charge may apply. It’s worth doing your research and understanding the full details of a loan before signing on the dotted line.
If you think consolidation may be the right choice for you, or if you’re looking for an outline of the steps that may be required, here is an outline of the process:
Firstly, you may want to identify your outstanding debts. It may be worth mapping them out; understanding exactly what repayments you’re making, within what time frames, and at what interest rates you are paying on each debt. You may want to check if there are any early repayment charges on your outstanding debts, or any 0% interest rates also to give you a clear picture of your current finances so that you can make an accurate forecast for the future.
Secondly, having reminded yourself of your existing debt conditions, you could look to create a forecast. By creating a forecast for the coming months and including key metrics that affect your business’ operations (such as your levels of working capital), you could develop an understanding of exactly how well, or poorly-equipped you are to make your outstanding repayments.
Finally, by calculating the debt-to-income ratio for your small business, you can combine the steps above to determine exactly what conditions you’ll require from the consolidated loan you’re looking to pursue.
We hope that this article has provided a clear overview of how debt consolidation and refinancing works. We don’t offer a debt consolidation service ourselves, but we do understand the financial challenges small business owners face and must stress that there is support available out there for those in need of debt consolidation.