Sales are down, and the payments on your business credit cards, working capital loan and equipment financing are coming due. As you scramble for ways to create cash flow, you come across the idea of debt consolidation, where you take out a new loan to pay off existing ones. But is it a wise strategy? Sometimes it is. But it is riskiest exactly when the money coming in is shrinking.
There are two reasons to consolidate. The first is money. If you’re paying a high rate on a business credit card and a working capital loan, consolidating into one business line of credit might save you money. Another reason to consolidate is convenience. Maybe you have a credit card, a line of credit, a working capital loan, and an equipment loan. Four separate payments, bills and accounts to keep track of. Bringing them together into one loan or line of credit eliminates the confusion and hassle. But savings and simplicity don’t make a bad business decision into a good one. The problem with consolidation when sales are dropping isn’t that it is a bad idea per se: it’s that you’re often out of control of the terms under which you would do it.
Fixed Monthly Payments
But if your ability to pay that debt has become tied to your monthly revenue and that revenue goes down, how will you make the payments? When your revenue is constantly slipping, combining your debts into one loan might get you one payment. But it will also mean one big hit to your cash flow. If your debt consolidation loan is a term loan for, say, five years, then your interest rate is the same and your payment is fixed, whether the payments are annual or monthly. A decline in monthly sales is a risk to the success of the loan.
That is the catch nobody puts in the advertisement: a lower interest rate does not guarantee a lower monthly payment. With a credit card, you can usually get by on the minimum payment in a slow month. But with a term loan, you usually can’t pay only the minimum: you’ve got to make the full scheduled payment every month or you default. You will have to make those payments no matter how much your sales are down, which can be a painful risk when things are going badly. Low interest rates in lending are a double-edged sword. They help you with the interest rate, but they also trap you into fixed monthly payments that may not be as easy to swing as sales slip. Consolidating can also stretch out how long it takes to pay the debt off, depending on the terms of the loan. Does that mean that debt consolidation for your business is off the table? Not necessarily. But the danger of a new loan when sales are dropping and cash flow is already constrained must be clear.
What You Would Be Consolidating Into
If you still want to consolidate, know what you would be consolidating into. The SBA 7(a) loan, backed by the U.S. Small Business Administration and offered through banks and alternative lenders, typically carries the lowest interest rate, but it is also hard to qualify for. Lenders generally want excellent credit and a lot of paperwork from owners who can prove their businesses are profitable and sustainable. The trouble is, when your revenue is dropping, your business may not be deemed “qualified” anymore. A traditional term loan works much the same way, paying out a lump sum for a set monthly payment, at a slightly higher rate. Or you could use a business line of credit, which gives you a pool of cash to draw on when you need it. However, interest is charged only on the amount you borrow.
Cash Flow Problems
Remember that business debt consolidation is not a magic bullet that solves business problems. It might simplify your business and give you a better interest rate, but it doesn’t solve cash flow problems. Too often a new loan at a lower interest rate is just a reprieve for a cash flow problem. So before you apply, ask yourself a few hard questions. Have interest rates come down since you borrowed? If so, then your debt is costlier than it needs to be. The rates on loans and lines of credit follow the federal funds rate, which the Federal Reserve can change eight times a year. Has your credit score, personal or business, improved enough to earn a better rate? What kind of repayment flexibility do you actually need? And how does the payment schedule of the new loan affect your cash flow, compared to the old one? Was the payment manageable at the time? Are you certain it is manageable now? What if sales slip further? Who covers that? If revenue has fallen below the point when you can service your debt, your situation isn’t stable enough for a new loan.
Then there is the question of what happens after the old balances are paid off. Say you roll a card balance into a term loan. With a zero balance you might be tempted to spend again on the card. That’s potentially a bad idea. That’s where discipline comes in. Just because you’re able to pay with the card doesn’t mean you should. Keep charging and you owe both new and old balances at once. Consolidation only works if you limit spending on the cards and lines you just cleared.
None of this means consolidation has no upside. Consolidation can save you both time and money by making life easier and reducing interest costs. Lower interest payments can improve cash flow and free up money for other parts of the business, and rolling several balances into one can help your credit score, since credit bureaus don’t look favorably on too many outstanding debts. There is a common misconception among consumers and business owners that by consolidating their debt, they are wiping the “debt slate” clean. This is not the case. After consolidation, the aggregate amount of debt owed can change, but the debt is still owed.
If the numbers work, the process is straightforward. Start by listing every debt your business carries, with its balance, rate and payment. Seeing the whole picture lets you spot which debts are most costly and where you might save. Then shop banks, credit unions and online lenders, ideally ones with experience in your field. Compare interest rates and fees on all your existing debt to your new loan, line of credit or other debt. Pay careful attention to the repayment term. When you apply, the lender will want your financial information to help them make the best decision for you. Lenders will look at your assets, income, and debts to decide whether to approve your application and what terms they’ll offer. That means credit scores, revenue, expenses and existing debts, which is exactly where falling sales will show. If you are approved, use the funds to pay the old debts off in full. Focus on on‑time payments while avoiding new debt.
So is consolidation smart when revenue is falling? Before you consolidate, run the numbers. Is the lower interest rate worth taking on a larger payment and paying a balance back over a longer term? If not, then hold off. Consolidation can be helpful for making short-term cash flow problems manageable for a business. But longer-term problems need more than consolidation to fix. Falling short of the cash flow you need to pay off the new loan could mean you’re worse off than you were before. Finally, cash flow. Can you actually service the new loan? If you can’t, then no, it’s not the right move.
