This story is part of a series about financial literacy for small businesses in the Ypsilanti area. It is made possible by University Bank.
Accruing debt is part of managing both personal and business finances. However, it is important to understand the best ways to manage debt and the pitfalls to avoid when seeking debt for your business.
Jennifer Moon, an Ypsilanti-based loan officer for CDC Small Business Finance, defines debt management as “the overall process of assessing how much money you're making versus how much you're spending and making sure you’re not spending more than you’re making.”
Moon separates debt into two categories: good debt and bad debt.
“Good debt from a business perspective is debt that was utilized for suspension, scaling, or support of your business operations,” Moon says. "Bad debt is debt that is predatory or high interest."
Mark Koepf, vice president and director of government-guaranteed lending for Ann Arbor-based University Bank, says many small business owners turn to bad debt options – such as personal credit cards, home equity, or predatory lenders – to fund a new business idea. Instead, he suggests, these entrepreneurs should talk to their community bank and create a relationship with their banker to find better debt options.
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Ylondia PortisMark Koepf, vice president and director of government guaranteed lending for University Bank, helps a client at University Bank's new Ypsilanti branch.
Debt management is an important part of any business’ finances because it can allow the business to grow even if the business owner does not have a high amount of personal capital to invest initially. However, once someone understands the significance of debt management and the difference between good and bad debt, it is critical to understand the best and worst practices for managing debt.
Moon recommends that a business owner have a complete picture of their finances before speaking with a banker about a loan.
“Prior to speaking with a loan officer — about 60 days before a business owner thinks they're ready for capital — I would recommend pulling their personal credit report, addressing anything that's outstanding, and paying off any collections or disputing them if they are not theirs,” Moon says.
Koepf echoes the importance of preparation before seeking capital, emphasizing the need for a business plan and financial projections for the first 12 months of operation. There are important questions that need to be answered when making a business plan.
“What is it going to cost you, and how are you going to get repaid? At what point does the business go from operating at a loss to operating at a profit, where you can start being self-sufficient?” Koepf says.
Having up-to-date and properly filed taxes is also a necessary part of proper preparation when making a financial plan and approaching a loan officer for capital.
“It’s important to file your taxes correctly because if a business files its taxes and shows consecutive losses over recent years, it demonstrates that the business is not able to support an additional loan payment, let alone its current operations,” Moon says. This means a small business owner can avoid taking on debt they cannot manage and save themselves from incurring large amounts of tax debt later on.
The information included in prepared documents, such as credit reports, financial reports, and tax filings, is typically used to determine how much debt a business can accrue. The amount of startup costs, existing debt, credit score, and financial projections are all contributing factors in deciding how much debt is necessary.
One of the biggest pitfalls a business owner should avoid when managing debt is taking on too much or too many types of debt.
“One of the biggest mistakes a business owner can make when managing debt is taking on too much debt too early or intermingling personal and business debt, which can make it nearly impossible to refinance down the road,” Koepf says.
Taking on too much debt and misfiling financial information can be avoided through proper communication with a banker. Where you take out loans for your business and who you speak to about your debt is very important. University Bank offers online bill payments and credit score monitoring to assist with debt management.
“There are in-house tools that are at our customers’ fingertips, so they don’t have to get another app on their phone, use a third party, or even get out a paper and pencil,” says Jori Knight, branch manager at University Bank. “They can manage those items right where their money comes into their account and also manage those items in the same place.”
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Rickey PortisJori Knight, customer service supervisor at University Bank.
Additionally, as a community bank, business owners benefit from being able to communicate with a real person who is highly knowledgeable and will work with them to ensure their business succeeds.
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Rickey PortisJeremiah Muhammed, senior customer service representative at University Bank, talks to Jori Knight, customer service supervisor at University Bank.
“You get to work with an actual person at University Bank who wants to see the local community succeed, and we will attempt to steer everyone in the appropriate direction,” Koepf says. “University Bank is a true community-focused bank that strives to provide the resources, guidance, and products that our area’s small businesses need.”