The art of managing debt
Most businesses eventually must borrow money Learning the ins and outs can make all the difference
Most people who start a small business at some time or other have to borrow money and incur debt. How that debt is managed can often mean the difference between success or failure of the business. About 60 per cent of micro businesses in Canada with fewer than five employees fail within the first five years. Experts advise small business owners to preserve cash, limit the amount of credit they take on, and keep expenses to a minimum during the early stages.
“In small business, cash is king,” says Bob Glandfield, president and chief executive officer of the Innovation Synergy Centre, a not-for-profit organization in Markham that provides advice to small business.
“ If you’re working from your basement or your home, stay there until you have a steady source of cash flow.”
“ There’s no profit in driving a fancy car or having an office address,” he says. “ They won’t pay the bills.” The most common source of financing for small business owners is a line of credit from a bank or a financial institution that can be secured against a home or some other asset.
Other sources include “ love” money from relatives, small “angel” investors, and some small business government financing programs. Once money is borrowed, there are different ways to manage the debt. Most small business owners make the mistake of mixing personal and business debt.
“ People should separate their personal and business debt because you can deduct the interest on your business debt,” says Bruce Ball, a partner with accounting firm BDO Dunwoody LLP in Toronto.
Ball recommends that people have two lines of credit, one personal and one for business. They can be in the same name, but one of them must be used for business and there must be a direct link between the borrowing and an income-producing investment to be able to write off the interest.
There may be advantages to incorporating your business.
Generally, incorporation is used to limit liability. Unlike a sole proprietor who is fully liable for the debts of the business, a shareholder is not responsible for debts and other liabilities incurred by the corporation. But there are financial advantages to incorporation as well.
Active business earnings of a Canadian-controlled private corporation are eligible for special federal and provincial tax rates. And as an employee of your corporation, you can receive employment benefits that are deductible to the corporation and eligible for special tax treatment.
Ball says incorporation generally makes sense if you plan to leave some money in the corporation and if you can take advantage of income splitting by having a spouse or children subscribe to shares in the corporation and receive dividends from the profits of the business.
Glandfield says most debt and other problems in small business occur because owners don’t do enough initial planning and underestimate how much money and time is required to get the business up and running and keep it going.
“ You’ve got to plan and understand where you are, where you are going, when and what the cash requirements are at each stage of the business’ development,” says Glandfield.
“Don’t underestimate. It always takes longer and more cash than you think.”