Business owners must run two sets of books- one for their business budgets, and one for their personal budgets. And, they need to definitively separate their business and personal debts. Staying disciplined is tough, especially in the beginning when cash flow is tight. There’s always that temptation to put business revenue in your pocket and pay your personal bills out of the same pocket. Unless you clearly separate your business and personal financials at the start and stick to it, you’ll just end up in a cycle of borrowing from one to pay the other. You might, by coincidence, cover all your obligations- but the risk of loss will endanger your business.
What’s The Difference Between Business and Personal Debt?
Personal debt is a financial obligation that you’re legally responsible for as an individual. A personal loan would finance things for your consumption in your personal life- like a large television, a gaming computer, bedroom furniture, or a new car.
Business debt is therefore a financial obligation entered into by a business. Obviously a business isn’t capable of racking up its own credit card, so the business owner or partners are responsible for that spending. The company is liable for any debt entered into by an authorized person- that individual isn’t personally liable for the debt unless that person signed a personal guarantee or incurred the debt knowing that the company was in trouble. Businesses use debt to fund investment in growth, expansion, and innovation.
Be sure to read: Equity vs. Debt Financing: Which is Right for My Small Business?
What’s the Difference in the APR?
The Annual Percentage Rate (APR) is crucial when shopping for a loan. On credit cards, home mortgages, and personal loans, the APR includes the interest rate as well as the fees or finance charges calculated on an annual basis.
Business loans can be secured in many ways. Each has interest rates that reflect factors including credit scores, scarcity, limits, and more. Rates published in 2018 include:
- Secured Bank Loans 4.00% - 13.00%
- SBA 7(a) Loans 6.30% - 10.00% (maximum rates capped by SBA)
- Online Term Loans 7.00% - 99.70%
- Lines of Credit 8.00% - 80.00%
It also makes sense to develop and sustain a relationship with your lender. Lenders can make individual choices based on their confidence in your business and on the other accounts you maintain with them.
Why Borrow For Your Business?
Businesses will need funding. They cannot start without seed money for office space, supplies, equipment, technology, and more. Until a business is self-sustaining, it needs cash flow. Insurance, operating expenses, rent, utilities, and payroll need funding.
Even a business with momentum requires financing for facility and labor force expansion. You may also need funding for launching new products and marketing campaigns. And, businesses need support for risk management- they must have the cash to cover unexpected losses, catastrophic events, and natural disasters.
Can Your Business Owe Too Much?
Borrowing to support your business cash flow may seem to be the best option for all the reasons we’ve mentioned. However, borrowing to make changes also raises the business’ valuation. Too much debt may misrepresent the business’ expectations of itself and of others- in other words, the business could look better than it really is.
If you don’t approach borrowing with a short- and long-term strategy, you may wind up borrowing from the wrong sources. Be sure to check the lender out as thoroughly as they check you. Some investors lack integrity and/or bind you to contracts you’ll have trouble fulfilling. You want a few credible and supportive investors.
Check this: 6 Characteristics of a Responsible Business Lender.
Borrowing can create debt servicing fees and interest that cuts into a business’ profit margin and cash flow. If your monthly payment, including principal, fees, and charges, affects your profit margin, your business may be borrowing too much.
What Is Your Debt-To-Income (DTI) Ratio?
A debt-to-income ratio (DTI) considers how much you owe each month in comparison to how much you earn. Essentially, you add up all of your monthly bills and divide that total by your monthly income before taxes. Of course, you have a personal DTI and a separate business DTI- you shouldn’t combine or confuse the two.
How Do You Improve Your DTI?
Your monthly payments should not be more than 50 percent of your total monthly pre-tax income. This goes for your personal and your business finances. It’s here that you must not mingle funds, or you’ll only be hurting yourself.
To improve your DTI, you must reduce debt, increase income, and avoid new obligations. You can also reassign the debt, in a sense, by moving debt to lower interest accounts- but it’s always best to reduce it whenever possible.
One More Thing You Need to Know About Personal Debt and Business Debt
It helps to have a trusted lender that specializes in your entrepreneurial needs. Low-interest financing, credit lines, and term loans can be instrumental in keeping your business afloat.
This communication is provided for informational purposes only. It is not intended to be an advertisement, a solicitation, or constitute professional advice, including legal, financial, or tax advice, nor is StreetShares providing advice on any particular situation. This is not an offer of credit. All applications are subject to approval, no guarantee of funding.