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Small Business Management Article

Debt: The “Good”, “Bad”, And The Ugly Truth

By

Raymond D. Matkowsky

“Those who cannot remember the past are condemned to repeat it.”
-George Santayana, 1863-1952, philosopher and writer (In its original form)




When it comes to business debts and bankruptcies, George Santayana’s words accurately describes the situation as it has existed over the last few decades. I am a Baby Boomer. One advantage that I and many other Boomer executives have is that we remember history. Since many of us lived through it. It is very unfortunate many of the current crops of business managers do not have the memories and have been repeating history often.

According to the United States Small Business Administration, 50% of new businesses fail within the first five years and 66% during the first ten. There are also many well established businesses that are failing. Why?

Let’s put one myth to rest. Internet sales are not killing off brick and mortar businesses by the droves. Although they add to the troubles of brick and mortar business, Internet sales only account for slightly less than 10% of all sales. You have to look much deeper than the internet to lay blame. That’s where history comes in.

There are many reasons for business failures. However, a good portion of these are due to financial matters such as insufficient capital, over-investment, and poor credit arrangements. All three factors usually lead to heavy debts and debts have historically killed many businesses.

Toys R Us

Lately the news has been about Toys R Us. Besides the United States, Toys R Us had stores in Canada and Great Britain. They made 15% of toy’s sales. By far, the largest share of the toy market. Then why did they go bankrupt? They took on 5 billion dollars of debt that they could no longer service in spite of good sales.

Poor Management Decisions

Companies get into debt because of the bad decisions of their management. As an example, there is Gibson Guitars. Gibson faces a crushing debt of $560 million due this summer.

Gibson is a 116 year old company. Elvis Presley strummed a Gibson J-200. Eric Clapton played his famous While My Guitar Gently Weeps on a Gibson. B.B. King once ran back into a building that was on fire and he just fled to save his Gibson.

Gibson management tried to change the company into a “music lifestyle” company by buying pieces of consumer electronics companies and launching Gibson Brands. It did not work out well even though sales of guitars were strong. Because of these decisions the brand may disappear.

About 30 years ago there were two hardware chains that competed against each other in northern New Jersey (USA). Using a debt offering, one of the two decided to buy the other out and eliminate the competition. Shortly after completing the purchase a recession struck sending sales into the cellar. The purchaser could not service the newly acquired debt. Neither chain has existed for many years.

Management clearly did not have any control over the economy. However, in doing their “Due Diligence” they failed to take into consideration the economic conditions.

I have a personal friend who with his brother inherited a very successful dry cleaning business from their father. The business was profitable enough to give each brother a good upper middle class income. However, they reasoned that if one location was immensely profitable how about three? They borrowed money and opened up two more locations. It didn’t take long for them to realize that the three locations were not bring in enough money to maintain their incomes and payback the debt at the same time. Very small businesses are not immune to debt blindness!

I can go on and recite a half dozen more instances that occurred in my time. History is littered with debt related failures. But, it seems many people in management continue to “reinvent the wheel.”

Debt: Good or Bad?

There is no such thing as “good” debt. There are only degrees of evil. I am well aware that many businesses must take on debt to buy the raw materials for products they will sell later. The debts will be repaid at the end of the season out of their sales. Many people consider this “good” debt.

If you look at the 1930s you will see that many farmers borrowed money from small banks to buy the supplies that they will need for the season. Through no fault of their own, they were not able to sell their crops and could not repay their loans to local banks. In turn these banks could not repay the loans that they took out from medium size banks. Medium size banks defaulted on loans from larger banks etc. This was how the great depression started. This “good” debt really turned out to be bad.

You do not have much control over the majority of bad things that can occur after you take out that loan. The only control you have is to never take out a loan that you do not have a way to handle if the situation turns negative. Remember also, that on the average an economic recession occurs every four to six years. Will you be prepared for it?

Get A Grip On Debt

I or no one else can recommend a certain level of debt to carry. I or no one else can tell you how to manage your debt. You are the only person that can do that. Everybody, every company is different and requires a different approach to debt management. What I will recommend is that you get a handle on your present debt and decide on whether it is necessary or not and how to go about reducing it. Reducing it should be a goal.

You are paying finance charges on that debt. Reduce those finance charges! Remember, every penny you save in interest, is a penny that goes right to your bottom line. Every penny you save is a penny more in profit.

Debt does matter! It matters with the Federal Government and the economy. It especially matters for private business with more limited resources.


If you have any further suggestions, do not keep it to yourself. Help your fellow readers!

If you have any questions, comments or suggestions drop me a line at rdm@datastats.com.




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