Over the last ten years, we’ve had rock bottom interest rates. Low-interest rates, courtesy of central banks, have made it easy for companies to load up on debt for all kinds of purposes, whether it’s stock buybacks or building out their infrastructure.
But the level of corporate debt at many companies, both large and small, has got some commentators worried. Despite a slight fall in overall consumer debt, the debt held by businesses has been growing steadily over the last ten years and now stands at all-time highs in nominal terms. Large international firms have never taken on so much debt before.
For the average owner of a small business, debt doesn’t seem like a problem right now. Interest rates are low, and they’re going to stay low, right? The truth is that the interest rate environment of the future is unknown. Owners simply don’t know what will happen to the interest rate over the next few years. It could stay low, but if it goes up, then debt servicing will become a lot more expensive.
Should You Be Worried About Debt?
Small business owners and entrepreneurs need price signals to work correctly. If you hold a lot of debt, then the chances are that you do because you believe that with cheap credit you can create value and grow. But what would you have done if interest rates were, say, seven percent? Would you still have gone into debt to finance your business? Perhaps not.
This is why management consulting is so important. Management consultants educate business owners about the risk of holding debt and how they can reduce it. It’s not so much that the debt isn’t serviceable right now – it is. It’s that the future could be very different from the past. Interest rates might have to rise because of inflation, and if they do, then individual business owners who hold debt could get into a lot of trouble.
The Debt Time Bomb
The problem before the last financial crisis was that homeowners were levering up on debt to buy homes that they couldn’t afford. When they couldn’t pay, there were ripple effects throughout the entire financial system, which led to several bank failures. We could be looking at a similar thing, but this time around the in the commercial sector. The problem, as before, is excessive debt. Just like homeowners lost their homes, many business owners could lose their businesses in a high rate environment, which makes it imperative to get debt down now.
How Can Businesses Cut Their Debt?
Cutting debt isn’t easy, especially if you run a capital intensive business. But the key to the process is to scour your firm for potential cost savings, wherever you can find them, and to use these savings to boost your free cash flow rather than reinvesting them. Remember, with cheap interest rates; reinvestment might seem like a good idea. But interest rate risk is something that many small businesses are failing to consider. It could come back to bite you.
