As an entrepreneur, it is essential to understand the exact difference between bad debt and good debt. Bad debt is the amount which you cannot leverage while growing your business. It is also referred to as reductive debt. It’s the sum which is not working in any productive means. Typically, it implies to purchasing things which are not affordable otherwise, and when it happens, you can always ensure that it will never produce you with any good outcome.
On the other hand, good debts come in the form of mortgage, loans, and lines of credit which can be used fruitfully for the benefit of the company. It can be termed as productive debt. Get in touch with Liberty Lending for easy loans in few minutes.
In this post, we will discuss three reasons which are responsible for entrepreneurs getting into bad debt.
Pressurizing too much on the business
Sometimes it so happens that entrepreneurs try to live using the income they are making from the business in the initial days. They simply just quit the ongoing job and give their best to develop the business. They fail to realize that they are not in the position to get the monthly salary which is required to live on. A company needs time for maturing, and reinvestment is essential. A certain amount of time is required along with adequate reserves to ensure continuous cash flow. It is vital to maintain a second job option to give the required breathing room for your business at the initial stage. Before leaving the job, it is essential to understand that your business is ready to provide you with the monthly check that you required to live on.
The ups and downs of the cash flow
When the cash amount is rolling in, there is not anything more exhilarating than this. However, the dramatic ups and downs are sometimes underestimated by the business owners, and they are not able to foresee the months of dreadful cash flow. A credit card is used to smoothen out the ups and downs of cash flow so economic balance can be maintained in the personal life. At the same time, it is also assumed that it can be easily cleared off in the next month. And when it is not possible, then the main crisis actually begins.
Being highly overconfident
At times, entrepreneurs use debts with the belief that they are doing it cautiously and wisely. However, it is not true in reality because they are simply overextended. In a typical manner, it can be explained that the entrepreneur simply enjoyed a few years of success and earnings and then decide to expand the business with the help of debt financing further. At the same time, they also change their lifestyle according to the new income level. And now when the downturn in the economy appears, or there is a loss of significant business clients or a vast change in the industry – it directly results in lack of profit earning. Things become rough financially, and the situation goes out of control leading the entrepreneur at the risk of losing the business.
How can you overcome bad debt?
It is essential for your future success to expunge all that debt out of your business as early as possible. Debts snowball is known to be one of the best ways of getting rid of bad debts. This strategy of analysis or spreadsheet can help you to get out of this problem even quicker than you can imagine.
The primary procedure behind the debt snowball is:
- Creating a specific and simple plan
- Sticking to the plan you create
- Celebrating the success
First, you need to determine the monthly income before you commit to eliminating the bad debt. Be cautious while committing the amount because you need to stretch yourself in order to ensure that the amount is paid off every month so that the plan is successfully maintained.
Next, you need to create a list where all bad debts should be entered in proper order. Begin with the most significant number at the top of the list and consequently ending with the smallest amount at the bottom. Also, you have to calculate the minimum payment you can afford to pay every month to each debtor on your list.
Now the plan is ready! So, simply start working on it.
Simply start by paying the committed amount every month to each of the debtors and try to add any extra cash it possible to the smallest debt. And keep on continuing to meet the minimum payments for all the pending payments. And soon, the smallest debt amount will be repaid fully. Now you can see that the snowball increased in size and all the amount that you were spending to clear of the small debt will now we used for clearing the large debt along with the normal regularly settled payment. You can continue making this increase payout for clearing of the debts until everything is cleared off.
How is it possible to stay away from reductive debt?
In the first place, the best way to stay out of getting into bad debt is to simply avoid taking too much loan which you cannot repay.
It is necessary to plan in advance if you want to stay out of bad debt. Below, there are some business practices which will help you to ensure that you stay away from reductive debt while expanding and going your business.
- Hire new employees only if you can afford to pay them. When you will find that your business has become big enough so that you can accommodate the payment of the new employees, only then you should take the step. Do not hire employees in advance with a hope for better business growth.
- It is essential to have an adequate reserve of cash in order to deal with emergency situations as well as a potential downturn that may appear in your business at any point in time.
- Do not overextend yourself with debt accumulation. You need to be cautious and try to always roll the profits of the business without continuously adding capital from your personal sources.
- Avoid leisure spending and consider the opportunity cost while taking financial decisions.
- Constantly keep on minimizing the expenses.
As a business entrepreneur when you find that you are in such a situation where the diplomat is working against you and no longer providing you with any sort of productivity, then you need to ensure that the burden is disappeared quickly. An entrepreneur who understands how troublesome it is to deal with that it will take quick actions to remove it and move on with the business in a successful. At this point, all laser expenses should be cut off, and the major focus should be on paying off the debt amount. Always remember staying out of reductive tape should be simply a part of the operating plan and not reactionary.
About The Author
Marina Thomas is a marketing and communication expert. She also serves as content developer with many years of experience. She helps clients in long term wealth plans. She has previously covered an extensive range of topics in her posts, including business debt consolidation and start-ups.