How Quickly Can You Deleverage the Business
The economy is in flux, interest rates have increased over the past year and lenders are starting to be less flexible on their loan covenants. Business executives need to be completely aware of their business’s financial condition, especially how leveraged the balance sheet is and loan covenants that relate to the debt on the balance sheet. Then the business executives need to understand how rapidly and what manner is best for them to deleverage their business.
Deleveraging is the act or actions taken by a business to reduce its leverage (debt). Business’s generally deleverage in a rapid manner by selling assets to pay down or off debt. When a business is unable to deleverage, it can be perceived as having an increased credit risk for defaulting on its financial obligations.
How does a business get into the position where it needs to deleverage – simple – the business has taken on too much debt for whatever reason (startup capital, the need for new capital equipment, building a new production facility, etc.) and the business can no longer support the leverage and the related repayment(s) of the outstanding debt.
How can a business deleverage? For starters consider:
- Deferring or cancelling all capital expenditures.
- Sell off unproductive assets, start with production equipment that is no longer in service.
- Sell old and obsolete inventory, even if below cost.
- Reduce operating expenses. This may mean closing offices, reducing operating expenses, headcount reductions and implementing a hiring freeze.
- Reduce research and development expenses.
- Shrink the business by reducing revenues, by no longer selling to low margin, high maintenance customers, which are of limited value to the business. Reducing revenue will reduce the business’s accounts receivables, which will provide cash to the business.
- Tighten customer credit policies.
Though all businesses are different, there are many ways to deleverage the business to generate cash quickly and, in many cases, improve the business’s operations and increase profitability. The key to deleveraging the business is that the executive(s) need to make quick decisions and avoid the temptation to think that the industry, economy or cash problems will either go away or self-correct.
No leverage problem goes away without action!