Maintain Earnings Through Debt Refinancing

If your firm is experiencing difficulty paying its current debt load, then debt refinancing may be a solution for you. Debt refinancing can be useful in supporting company operations, but it carries with it certain financial risks. It can help to increase shareholder value and it has the ability to reduce the consistency of the firm’s cash flow. The focus of a small business owner should be to maintain the stability of earnings, which will help foster better relationships with creditors, and business credibility.

Refinancing Options

The debt service of loans with floating rates or fixed credit amounts can exploit varying amounts of operating cash flow. Increasing debt payments in a period of decreasing sales can have a significant negative impact on a firm’s earnings. In order to reduce the potential for increasing debt payments, owners must develop a debt management strategy that can replace risky loans with ones better suited for the business.

If employed correctly, debt refinancing can consolidate various credit lines and other credit vehicles into one contract that can be maintained more efficiently.  It is easier to make the correct payments on time when administrating a single loan. Debt refinancing can also replace variable rate borrowings with fixed rate loans that are easier to forecast and manage.  In order to determine the correct type of financing for the business, management must understand the various financing options that are available. If current market rates are lower than the loan rate, then a simple debt refinancing can result in lower monthly debt payments and an increase in operating income.  More complex refinancing can be completed to repair a flawed capital structure and may also be used in times of financial distress. When borrowers are having difficulty making their payments, many lenders will restructure debt financing, forbear or defer interest payments, and even write off portions of the principal in order to allow the borrower to continue paying the contracted debt payments.

Research Financing Opportunities

Once a refinancing strategy has been developed, the next step is to research potential loan terms and lenders.  It is important that owners have established and maintained their business credit so that they can obtain the best loan terms from the financing institution. Successful debt refinancing will also be dependent on the value of the assets that back the loan.  It is important to ensure that any assets, business or personal, that are pledged to the financing company as collateral for the loan maintain their value.  The loan principal is often determined as a percentage of the pledged assets. If the value of the assets have diminished since the loan was originally made then the size of the refinanced loan may be reduced accordingly. In periods of economic strength it is common for principal values to stay the same or increase, while in recessionary periods, debt refinancing can result in smaller loans.

Once a lender has been chosen and provisions, such as interest rate, principal amount, and loan term, have been negotiated then the loan is underwritten and closed.  To aid the financing company to determine the potential financing risks, owners are usually required to provide several years of financial statements, tax returns, capital leases, property deeds, and any other income or expense related items that could be used in preparing a financial forecast.  If the financial forecast does not demonstrate that the company can easily cover its debt service requirements, then owners may be asked to provide a personal guarantee and pledge personal assets as loan collateral.

Even after the loan has been made it is imperative to build a good business relationship with the lender so that they will provide the appropriate services during the loan period and act as a business partner should the company ever have difficulty in making its contracted debt payments.  Recommendations and testimonials from lenders will also be valuable in building business credibility and obtaining favorable terms from other creditors and supply vendors.

Research Refinancing Market

Implementation of a successful debt refinancing strategy also requires performing considerable market research.  In addition to finding the best lending institution with the most appropriate loan program for your particular company, owners need to determine if there are alternative, less expensive means to achieve the same ends.  Debt refinancing includes various costs that are determined on whether an owner uses a refinancing specialist (or broker) or deals directly with the lending institution. Every individual in the process will require a fee that is either paid directly or is imbedded in the financing rates.

Federal and local governments may be a source of inexpensive business loans, providing refinancing programs designed to foster small business expansion.  In connection with the Small Business Loan Act of 2010, the Small Business Administration (SBA) has been providing government guarantees to help reduce the cost of financing to small businesses.  Before negotiating with any lending institution, owners should research the market to determine what government support is available to make debt refinancing valuable. If a less expensive small business loan program can be found then working with a financing specialist with ties into these SBA programs may be worth the additional brokerage fees.

Beware of Debt Refinancing Scams

Research is also required in determining which of these specialists and lending institutions are reputable.  Unfortunately there are many individuals that use the debt refinancing market as a means to take advantage of unsuspecting business owners.  Sadly, it is often financial distress that makes owners first consider debt refinancing and it is the need to increase income quickly that makes owners susceptible to the many lending scams that are committed.  When researching potential lenders, or brokers, make sure to research their track record, by using services such as the Better Business Bureau and testimonials from previous clients. Always review any contracts or legal documents that must be signed and employ the services of an attorney knowledgeable in debt refinancing.

Conclusion

Debt refinancing can be a good way to help stabilize a company’s income stream and usually makes sense when lending rates are at historic lows.  Being able to pay interest and principal payments in a timely manner will help increase business credit and make it easier to obtain additional financing or favorable terms with vendors.  If your current business loans are affecting your ability to maintain stabile operations, then refinancing into new loans that are better suited for your business will go a long way in enhancing its credit profile and maintaining business credibility with vendors and customers.