The 5 Biggest Causes Of Business Debt

top budget categories

The average small business carries about $195,000 of debt. That’s a lot of money owed to other people. 

Debts can sometimes be necessary for business. However, many companies end up relying on loans and credit cards unnecessarily. This can lead to debt building up, resulting in large debt repayments and smaller profits. Eventually, some businesses reach a point when they can no longer pay it all back – this is when many companies go bust.

By learning to avoid debt, you can maximize your profits and keep your business afloat. But just how do you avoid debt in business? Understanding the number one causes for borrowing money and getting into arrears can help you to prevent uncontrollable debt. Below are just some of the biggest causes of business debt.

1. Equipment Purchases

Starting a business can be very expensive. There could be a lot of equipment to acquire, and unless you have a lot of equity up front, you may not be able to buy this equipment in cash. As a result, many startups turn to loans.

Borrowing money for equipment may be necessary, but many businesses often borrow more than is necessary. By reducing the amount you borrow from the start, you can avoid launching your business with vast amounts of debt. 

Below are a few ways to avoid debt as a result of equipment purchase:

  • Purchase only what you need: While it’s important to have good quality machinery, you don’t need the best machinery available if you’re only a small startup. Avoid splashing out on technology that is beyond your means.
  • Consider used equipment: Used equipment can be a lot cheaper than brand new equipment. However, business owners should avoid heavily used machinery as it will likely be in poor condition. Look out for gently used machinery – it could be cheaper than brand new machinery while requiring minimal maintenance.
  • Lease equipment: Leasing equipment could be a debt-free alternative to owning equipment. You’ll pay less upfront, and you may be able to gain access to top-quality equipment that you may not otherwise be able to buy. 

2. Poor Budgeting

Many businesses get into debt simply as a result of poor budgeting. Many business owners are too busy to check their finances and end up making reckless decisions that may result in overspending. Taking the time to budget could make you think twice about using your credit card and prevent you from getting into arrears. 

Below are a few ways to become better at budgeting in business:

  • Check your accounts: By knowing exactly how much is in your account, you can avoid spending more than you have. Having mobile access to online banking could help you check your funds to determine whether there will be enough in your account after paying the bills – before you make an unplanned transaction. 
  • Forecast your earnings: When it comes to making long-term financial decisions, it can be important to forecast your earnings. Before deciding to spend more each month, make sure that you have the potential to earn more each month – especially if your return is currently quite slim. 
  • Calendar your payments: It can be useful to know precisely when future payments are going out. This can help you to control your spending so you’ve got enough in your accounts for these payments, preventing you from getting into arrears or having to take out loans. 

3. A Lack Of Customers

A lack of customers means a lack of revenue. If there’s not enough money coming in, you likely won’t have enough money to cover expenses going out. Perhaps you own a service-based business and the reason why your customers don’t come back is that the booking process is complicated and tedious. By automating your scheduling process, you can provide top-notch customer experiences and build strong customer relationships. In addition, you’ll increase attendance and revenue by allowing your clients to schedule during non-business hours.

There are many ways to attract more customers and up your revenue:

  • Up your marketing: Marketing is essential for attracting customers. Consider whether it’s time to up your marketing game. Paying for marketing could help you get the best results – however, there are still many ways to efficiently market your business for free.
  • Nurture leads: Once you’ve attracted customers, make sure you then nurture them so they’re more likely to commit. Attracting lots of visitors to your store or lots of traffic to your website is great, but if you can’t get them to buy your product or service, then it’s all for nothing. This guide to lead nurturing could be worth reading if you find that potential customers keep slipping away. 
  • Reconsider your products/services: If you’ve been struggling to attract customers for a while, consider whether it’s time to change or expand your products/services. Your products/services may be too general, or they may be too niche. It may even be a simple case of tweaking your current product slightly to appeal to a greater audience. 

4. Late Paying Customers

It’s possible you may be attracting customers but your customers may not be paying up. Late payments can often cause a chain reaction. When you’re not getting paid on time, you may struggle to pay your suppliers on time. 

Any business that deals with repetitive payments is likely to deal with late payments. Manually chasing up payments is the most obvious way to deal with late-paying customers. However, this can be stressful and challenging – and its’ not the only way to deal with late payments.

Below are just a few ways in which you can reduce late payments:

  • Vet your customers: Some consumers or businesses may have a poor track record of paying people on time. To save you the stress of continually chasing payments, it may be better to avoid these customers altogether. A credit check could be one effective way of checking whether customers are financially responsible.
  • Automate invoices and reminders: Late payments can sometimes go unnoticed. In some cases, businesses may even forget to send out invoices in the first place. To ensure clients are always promptly invoiced and followed-up, it could be worth automating your invoices and late payment reminders. Some programs and apps can help you do this. 
  • Consider early repayment incentives/late payment penalties: You may be able to offer incentives such as discounts to encourage customers to pay early. You may similarly be able to encourage customers to pay up by charging late payment fees. 

5. Lack Of Emergency Planning

Often, businesses borrow money to pay for emergency costs. Such emergencies tend not to be budgeted for – they could include tech problems, lawsuits, or even victimization such as burglary. 

Every business needs to be armed against emergencies. Sometimes there will be no choice but to borrow money. However, there are ways in which you can reduce the potential amount of money you may need to borrow:

  • Protect your business: Insurance policies such as public liability insurance, tool insurance, or cyber insurance can pay you compensation in the event of an emergency, preventing you from needing to borrow money. Consider whether your business could benefit from taking out additional insurance
  • Set up a rainy day fund: It could be worth setting up some savings to dip into in the event of emergencies. Having savings set aside could reduce the amount that you may need to borrow. 
  • Invest in preventative measures: Many emergencies are preventable – or, at the very least, can be planned for by investing in defenses. Investing in strong security measures could prevent you from having to take out a loan to pay for burglary reparations. Similarly, maintaining machinery could prevent you from having to take out a loan for unexpected repairs. 

Wrapping It Up

Some businesses are successful by leveraging debt to their advantage. However, many small business owners fall victim to overextending themselves financially and being overcome with debt. If you must take out loans for your business, be sure you err on the side of caution and use debt sparingly.