How to Conquer Business Debt: Consolidate vs Refinance

For many businesses, carrying debt is a matter of course, and for some enterprises, both large and small, this need not be a problem provided it’s handled properly. As long as the fundamentals of an enterprise are strong and the company has the cash flow to manage repayments comfortably, an acceptable amount of debt can even be helpful to a business, making it easier to get credit for future projects.

Indeed, figures from Deloitte show the amount of debt taken on by enterprises over the last few years has grown significantly, which the firm said is no surprise as companies look to take advantage of historically low costs of borrowing to grow their operations and expand into new areas.

But while this may have been a normal way of doing business during one of the longest sustained periods of growth on record and with interest rates low, having too much debt on the books is always a business risk, even more so if the economy enters more turbulent times.

While large enterprises may have been comfortable with their levels of repayment for a while, things can change quickly in the corporate world. A downturn in the market can quickly disrupt your cash flow and leave you struggling to meet your repayment responsibilities, and if you don't manage this carefully, it could have serious consequences for the future liquidity of your firm.

When should you be looking to tackle your debt?

The first step is understanding when to take action. Leave it too late and you'll find yourself unable to service your debts and be past the point of no return, but jumping the gun could leave you facing unnecessary costs and interest payments.

A key sign you need to tackle your debt now should be when it’s having a significant impact on your cash flow. Even if you're making money, if the majority of your working capital is being used to service debts, this will seriously hinder your business' ability to grow.

Meanwhile, if you're only just in the black at the end of the month, this increases the risk of defaulting on your debts, as it will not take much to tip you over the edge. The consequences of defaulting can be potentially fatal to any business, so it's important to take action before this becomes a real likelihood.

Consolidation vs refinancing - what are the benefits?

This is where consolidating or refinancing your debt comes in. These are the two most common solutions for repackaging your debts into more manageable forms. Even among large enterprises, these terms are sometimes used interchangeably, but this isn’t the case. In fact, there are key differences between the two that it's vital to be aware of.

Both involve applying for new loans that will offer more favorable terms overall, but refinancing refers to taking out a new loan in order to pay off a single existing debt, while consolidation involves amalgamating two or more loans into one single borrowing.

If the majority of your debt is in service of one particular loan, such as a business mortgage, for instance, refinancing can offer you the breathing room you need to improve your finances. For example, if your refinancing loan has a longer term than your existing one, this will mean lower payments each month. While the tradeoff is that you'll be carrying debt for longer, it can ease any cash flow issues. Alternatively, negotiating a loan with a lower interest rate will also help you in the long run.

If you have multiple loans, each with their own interest rates and payments terms, consolidation is a good option as it can greatly simplify your accounts. Turning these multiple payments into a single debt, where you’re dealing with just one provider, means streamlined, easier payments, so you have to spend less time each month worrying about dealing with debt.

Another benefit is when you have multiple short-term loans with high interest rates, then this approach can also prove beneficial, as it can remove the worry associated with these borrowings and turn them into a more manageable, longer-term package.

The disadvantages to be aware of

Whichever option is right for you, there are some caveats to be aware of. Whether you're consolidating multiple loan repayments or refinancing a single, large debt, it will involve paying off what’s owed in the original debts, plus interest.

Therefore, you could well end up paying interest on top of interest on the new loan; even if the headline interest rate on a refinanced or consolidated loan is lower, you may find yourself paying more in the long run. It's therefore vital you do the calculations and determine if this will be the case, and if the positives of lower monthly payments outweigh this risk.

Ultimately, you should be viewing debt consolidation or refinancing as a temporary solution. It may ease pressure on your cash flow in the short term by reducing monthly payments or lowering interest rates, but it won’t address the fundamental issues that have led to the situation arising. However, it can give you the time you need to adjust your business strategy to boost your cash flow and ensure you're able to manage your payments more effectively in the longer term.