Don’t Let Your Business Be Debilitated by Debt

The following is adapted from Protect Your Profit.

More than 20% of businesses fail in the first year. By five years, around half of businesses close their doors, and only about a third make it past the ten-year mark.[1] One of the biggest reasons? They simply run out of money, often due to debt. Debt is a huge obstacle to overcome in business—one that my client Robert has unfortunately found himself facing.

To fund his solar business, Robert used several credit card accounts—seven, in fact—along with credit from his vendors. Like many business owners, he had a bookkeeper whom he loved. She came to work every day and seemed reliable and skilled. He also had an outsourced CFO who came in one day a week. The CFO was modernizing the accounting system, moving the whole system from one platform to another. When he came in each week, he would give the bookkeeper a to-do list of data that needed to be reentered into the new system. The bookkeeper soon became overwhelmed because in addition to keeping the books, she had to answer the phone, help with other administrative tasks, and now reenter all this data.

While the bookkeeper was falling more and more behind, Robert continued receiving financial statements each month that made it seem like he was making tons of money. He was working on getting all his credit cards paid off, and he felt like the business was in a great place. Based on the positive numbers of growth he was seeing, he even made moves to expand. He hired new team members, pursued more advertising, and invested in new equipment.

Then one day Robert got a call from one of his vendors saying, “You owe us $250,000 for solar panels.”

It was like a bucket of ice water to the face. Robert didn’t have $250,000 just lying around. How could this have happened? he wondered.

With some investigation, Robert discovered that his bookkeeper had gotten so far behind that she hadn’t entered any of the vendor invoices into their system for months. All the invoices were just sitting in a drawer. Because the invoices had never been entered in the system, none of those costs were recognized on the profit and loss statement, resulting in the vastly overstated profit numbers Robert had been working from for several months.

At this point, Robert fired both his CFO and bookkeeper. Neither the CFO nor the bookkeeper had malicious intent, but their ineptitude had cost Robert dearly. The bookkeeper only had the skills to enter data; she didn’t know how to analyze what the various financial statements said and didn’t understand how they corresponded back to the data she entered. On the CFO’s part, he was completely sidetracked by his mission to rebuild a new, better system for tracking costs and somehow failed to notice that the very thing he was trying to track wasn’t being updated in the system.

It was a calamity of errors, and because there was no double-checking system in place—no checks and balances, no definite policies and procedures—no one noticed anything until the vendor called. Robert had made the mistake of implicitly trusting the “professionals” he’d hired. He wasn’t asking questions or double-checking, so everything fell through the cracks.

Left to pick up the pieces, Robert went back to his old accounting system and started all over again. With a new, accurate set of numbers finally in hand and a mountain of debt to overcome, he was forced to radically change his entire business. He also had to let half of his team go because he didn’t have the money he thought he did to pay them.

Robert discovered this debt about a year and a half ago, and he’s still struggling to overcome it. For a year and a half, he has not been able to cut a paycheck for himself out of his business. His wife, who had been a stay-at-home mom, had to go back to work. His kids’ lives have been turned upside down too. Robert is now the one to pick them up from school because his wife is back at work. Many days, he takes them on sales calls with him. He can’t leave them home alone and can’t afford a sitter, but he must continue to drive sales to keep the business afloat. At this point, it is borderline whether his business will survive this setback or become just another statistic.

Nobody wants to be in Robert’s position, and there are several causes of debt that you should avoid in your own business:

• Not putting bills in the system. When the bills aren’t in the system, there is no way for you to have an accurate pulse on your business’s health and financial obligations.
• Holding checks. Another easy way to fall into debt is holding checks—you properly input the bill into the system and then cut the check to pay it, but you don’t have enough money in your account to cover the check, so you hold on to the check for days or weeks, not sending it until the needed funds become available. Instead, you should wait until you have the money in your account to cover the checks and then cut the checks. That way your financial statements will be correct at all times throughout the process and will accurately reflect your true cash reserves.
• Commingling funds. The second you commingle personal and business funds, you’re bound to lose track of important initial investments. The day you open your business, you should open a business banking account. Deposit any and all investments and seed money into that account, even if you’re borrowing from your line of credit. Then spend out of that account. Doing this will create a trail showing the deposits and will ensure that all personal investments and seed money spent on the business are recorded and can thus be paid back someday.
• Forgetting about credit card expenditures. It is so easy to charge something and forget about it. If you forget to transfer those transactions over to your general ledger, though, it will look like you’re making a profit when you’re not. It is especially important to track credit card debt because the interest rates are so high. Whenever it is possible, don’t finance your business with credit cards. There are more cost-effective options available to you, such as opening up a line of credit with your bank.

[1] US Bureau of Labor Statistics, “Chart 3: Survival Rates of Establishments, by Year Started and Number of Years since Starting, 1994–2015, in Percent,” last modified April 28, 2016, https://www.bls.gov/bdm/entrepreneurship/bdm_chart3.htm.

For more advice on avoiding debt, you can find Protect Your Profit on Amazon.

Elizabeth Hale is the founder of eeCPA, which has been providing clients with customized accounting solutions since 2004. Hale has worked with small- to medium-sized businesses for more than twenty-five years and has owned and operated several businesses. In addition to being a member of the American Institute of Certified Public Accountants and the Arizona Society of CPAs, she serves as the finance director of the Entrepreneurs’ Organization. Hale lives in Scottsdale, Arizona, with her three children.