How to Avoid Business Bankruptcy with Financing

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Why do businesses go bankrupt?

As a business owner, the thought of going bankrupt can fill you with fear and trepidation, especially when the economy is struggling or your company is facing hard times. The fact is, 20% of new businesses fail in their first year, and only a small percentage last long enough to become institutions.

So why do these businesses fall into bankruptcy? And just as importantly, how can you avoid such a costly mistake? Keep reading to find out, starting with four of the most common reasons small businesses fail:

  1. Incomplete business plan – A good business plan is more than just an idea in your head or a piece of paper that is required by investors or lenders. Your business plan is your data-backed roadmap that keeps you focused and on task when distractions arise. It should cover details about potential obstacles for the business, including market competition and financing needs, as well as a formal plan for the organizational structure and income sources of the business. Entrepreneurs that have a proper business plan are more likely to avoid bankruptcy during the early years because they have planned ahead, they understand the marketplace and the competition, and therefore have a better chance of responding well to adversity.
  2. Inaccurate financial records – Small businesses that have incomplete bookkeeping and accounting processes are among the most likely to fail in their first year. Without having the proper tools to financially plan for operating expenses and debt schedules, business owners risk defaulting on current loans and being unable to cover future obligations.
  3. Rapid growth – Expansion, whether physically or financially, is often the goal of entrepreneurs. However, scaling your business before the current financial position is stabilized can lead to financial ruin. If the priority is to increase annual revenues, it’s important that business owners make educated, well-informed decisions about expansions, renovations, and securing additional capital through debt.
  4. No marketing strategy – New businesses need customers and revenues to succeed. However, most types of businesses must implement some marketing and advertising strategies to attract new customers. Companies that have a documented marketing plan in place are more likely to avoid bankruptcy due to a decline in sales revenue or net income. Whether it’s through social media marketing, creative signage, or television ads, marketing is a must.

How to assess your small business’s financial position

One way small businesses and nonprofit organizations differ from large corporations is the flexible financial reporting requirements. While publicly traded companies and large incorporated entities are required to publish their company’s financial statements quarterly and annually, many small business owners and startup entrepreneurs go long periods without preparing or reviewing an income statement, balance sheet, or cash flow statement. If something goes wrong when you’re running a business this way, you may not know about it until it is too late to do anything about it.

One of the best ways to avoid a financial crisis like bankruptcy is to keep on top of your financial health. Aside from reviewing financial records and understanding your business’s bottom line, there are several financial metrics that can be used to measure financial health quickly.

Gross profit margin

Gross profit margin measures the financial health of the company by looking at profitability. The gross profit margin is calculated by subtracting the cost of goods sold (COGS) from net sales. Any profit measured indicates that the business is making more than it is costing.

Gross profit margin = Net sales – COGS

Revenue growth rate

The revenue growth rate compares current revenues to prior periods. The revenue growth rate is found by subtracting the current period’s revenues from the same period last year’s revenues and dividing that difference by the prior period’s value. A positive percentage indicates a successful business.

Revenue growth rate = prior period’s revenues – current period’s revenues

Debt-to-income (DTI)

The DTI calculator helps small business owners and lenders understand how much of the business’s revenue is being used for debt payments on loans, lines of credit, and other financial liabilities. The ratio measures insolvency, by evaluating whether the business can pay its bills. Small business owners can evaluate their DTI to gain insight into making decisions about funding options, expansions, and staffing.

DTI = Recurring monthly debt payments/gross monthly income

Operating strategies to avoid bankruptcy

If assessing your finances leaves you concerned about your business’s future, there are some steps you can take internally before reaching out to a bankruptcy attorney or getting a second job. Consider talking to your current lenders to arrange modified debt repayment or working with a management consultant on a business reorganization. There are also several credit counseling programs offered by both lenders and law firms that can help entrepreneurs avoid Chapter 7 or Chapter 11 bankruptcy. Some more direct actions you can take today to change the direction of your financial health include:

  • Reduce expenses – Cutting costs will free up more cash flow, which will allow the business to focus on paying down debt and increasing working capital. Some ways to reduce operating expenses include canceling non-essential subscriptions and software licenses, postponing large purchases, laying off staff members, and renegotiating contracts with monthly vendors and suppliers. Reaching out to providers and sharing your situation is a great way to get a repayment plan in place for recurring costs, like utility bills.
  • Increase revenues – Strategizing to increase revenues before tough times is the best defense against unpredictable revenues. Whether your small business provides goods or services, some ways you can ramp up revenue include running a special on gift cards, recycling old inventory and selling it at a discounted price, and offering reduced service rates for current customers that commit to long-term contracts.
  • Collect receivables – Over time, unpaid invoices can start to add up, which causes a rising accounts receivable balance. Collecting unpaid accounts receivables is a smart way to increase cash flows and avoid liquidation. For clients that can’t pay invoices in full, consider offering a payment plan and setting up recurring payments for the agreed monthly payment. Another option is to offer a discount for customers that are willing to settle their debt quickly.

Financing strategies to avoid bankruptcy

There are several financing options to consider before filing bankruptcy, including credit counseling and debt consolidation or restructuring. If your business is making too many monthly payments to lenders, refinancing with a new lender might be a great option to lower your monthly liabilities and improve your creditworthiness. If your business lacks the necessary funds to launch a new marketing campaign or purchase inventory in bulk, a line of credit or term loan may be the best way to access fast funds.

 Every type of small business loan has different loan terms, eligibility requirements, interest rates, and funding methods. Before reaching out to a lender about business financing to avoid bankruptcy, get a better understanding of your options by preparing the following items:

  • Desired loan amount
  • Revised business plan and budget
  • Financial statements
  • Two years of business income tax returns
  • Personal credit report and business credit history
  • Current debt settlement schedules, for business debt and personal loans
  • List of business and personal assets

Once you’ve gathered some documents and gotten a better understanding of both your business’s creditworthiness and your business needs, choose a lender to work with. Traditional lenders, like banks and credit unions, offer low-interest, long-term loans for businesses with excellent credit scores. Alternative lenders, like Biz2Credit, can offer several loan programs, an easy online application process, and flexible approval requirements.  Once you’ve decided on a lender or narrowed the list down to a few, consider the following financing options as a way to increase capital and avoid bankruptcy.

Term Loan

A term loan is a traditional type of financing where borrowers receive a lump sum payment upfront and repay the debt over time with monthly payments. Long-term loans may be right for large loan amounts or for very large purchases, like commercial real estate. Short-term loans are common for small business owners that need additional cash flow to pay operating expenses, implement growth strategies, or compensate for seasonal revenue fluctuations. Term loans can be secured loans, where they use the borrower’s collateral to minimize the lender’s risk. This is beneficial to business owners that want a lower down payment or higher loan amount. Term loans typically offer lower interest rates and better repayment terms than other types of fast-funding loans.

SBA Loan

SBA loans are a type of loan program where the U.S. Small Business Administration guarantees a portion of each small business loan. There are many programs through the SBA including the SBA 7(a) loan program and SBA Microloans. The eligibility requirements for SBA loans typically require a higher credit score and at least two years in business, and the approval process can take up to 30 days. For entrepreneurs that can get qualified and wait for funding, SBA loans offer a great, low-interest financing option.

Business Line of Credit

A business line of credit is a type of revolving credit that works similarly to a business credit card. When a borrower is approved for a line of credit, a maximum credit limit is also approved. The borrower can then withdraw funds on the line of credit anytime they need cash for their business needs. Monthly payments are made up of principal and financing costs, calculated according to the annual percentage rate (APR). When the balance is paid down, the funds can then be accessed again.

Equipment Financing

Equipment loans, or equipment financing, are used by small businesses to purchase equipment or machinery, including computers, computer software, vehicles, construction equipment, commercial kitchen appliances, office copiers, and other fixed assets. The purchased equipment acts as collateral to secure the loan, so equipment financing is a great option for borrowers with bad credit or those approaching bankruptcy. The eligibility requirements for an equipment loan consider the value of the asset, the useful life of the asset, and the creditworthiness of the borrower.

Merchant Cash Advance

A Merchant Cash Advance (MCA) is a fast-funding option for entrepreneurs that collect credit card revenues and need to avoid bankruptcy. When approved for an MCA, borrowers receive a lump sum payment upfront and repay the loan plus financing fees using future credit card or debit card sales. The financing costs of an MCA are higher than other types of financing, but typically borrowers with credit scores above 525 can be approved if their business has been operating for 18-24 months.

Bottom line

Running a business can be a very rewarding and challenging task. It is important for business owners to know where their business stands financially, by regularly reviewing financial reports and financial metrics, like DTI. If you suspect your business is in trouble, consider refinancing current debts or seeking credit counseling before filing bankruptcy. There are also several financing options, like a term loan or line of credit, that can be used to avoid bankruptcy. Reach out to Biz2Credit today to ask about ways your business can retire high-cost debts as this New York City IT consultant did with a $100,000 line of credit.

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