What is Business Solvency, and How do I Stay Solvent?
Business solvency is the state of being capable of paying off all business debts in the long term. If a business is insolvent, then it is incapable of paying back the money it has borrowed and is therefore effectively bankrupt. Staying solvent is the first step towards becoming profitable and sustainable. Your business needs to bring in enough income to pay off any debt it is carrying. In this post, we’ll talk about why solvency matters and what you can do to attain it.
Most small businesses require some initial startup cash to get going. This will go towards buying equipment, rent for office space, materials and supplies, and other expenses. Since the business just opened, it doesn’t have any income yet. That’s why it’s common for small business owners to borrow the money they need. On the one hand, this gives you access to more money than you would be willing and able to risk from your own assets. On the other, it means that if you can’t pay back the loan, you will have to go out of business and shut down.
That isn’t the only time that businesses borrow money. Whether it’s a loan for an expansion, remodeling, or another new project or just to cover daily expenses until revenue comes in, businesses spend a lot of time in the red. Again, this is not a problem by itself as long as the company can pay back the money on time. Solvency means being able to make your payments and pay all your other bills at the same time.
Businesses become insolvent in one of two ways: by borrowing too much and by not making enough revenue. That suggests the two main ways of getting solvent: limit how much you borrow and avoid gaps or drops in revenue.
Before taking out any loan, do some careful analysis to make sure that it will be worth it. The revenue you get from the project has to exceed the amount of money you will borrow. If the math doesn’t work out, then you should probably consider a smaller loan or waiting until later on when you are making more money. If you take on too much in loans, then you’ll fall behind on other bills or expenses because you need to pay it off.
Think about whether what you are borrowing is necessary and if you can simply save some of your profits over time to pay for the project. That way, you will avoid the risk of a debt payment you can’t handle as well as the interest that the bank would charge you. A business that can pay for its own expansions and alterations is in good shape. You can also save money by budgeting for and tracking business expenses. By tracking these expenses, you’ll be able to look for ways to cut unnecessary costs in your operation.
Controlling revenue is harder than controlling debt because you have total control over how much you try to borrow. However, you are at the mercy of the market when it comes to revenue. Your business might do very well after a good ad campaign, or it might run into problems because of a bad review or a mistake in product design. Sometimes customers lose interest or switch to a different business because they like it better. You need to do all you can to keep customer opinion of you high. Review management systems can help, but even they can only do so much if you have a poor product or service.
Don’t borrow a lot of money when you don’t have enough revenue that you can count on. For example, if you work in a business with a lot of long-term contracts, then you run the risk of a customer or client not paying on time and delaying your income. That can jeopardize your solvency because even though that revenue should be yours, you don’t have it. Don’t base your predictions on gut feelings or hope: base them on how you have performed recently and the nature of your business.
As long as you stay on top of it, loaned money can help fuel growth. But if you over-commit to borrowing, you will find yourself unable to pay back the money. That means you have become insolvent and your business is no longer viable. You will likely have to enter bankruptcy to pay your creditors. Take a practical viewpoint towards loans, especially when you remember that you have to pay interest.
Overloading on loans can happen at any time, from the startup phase to a mature, stable company. You have to be careful with borrowing money even if your business is several years old because it can still become a significant burden if you are not careful. Be as responsible with business loans as you would with a credit card or mortgage to ensure that you will stay solvent.
Check out this article which talks about some other business mistakes one can make. If you want more information than that, make sure to keep an eye on our business section!