By Carl Faulds

Small and medium-sized businesses face unique challenges compared to their larger counterparts. They usually have fewer resources at their disposal and often face more challenges with cash flow.

However, they have one big advantage: they can take fundamental decisions and change direction much more easily. One change every small business should consider is debt refinancing. But why is this so important?

What Does Debt Refinancing Really Mean?

In simple terms, this means taking out one loan to pay off another. The most important factor, of course, is that the newer loan must be better than the older one: more affordable, more flexible, or capable of being repaid over a longer term to reduce your monthly expenses.

Of course, the first thing you’ll be looking for is a lower interest rate. Even a fraction of a percentage could make a huge difference if you have substantial debts and a long repayment period. If you’ve taken out particularly expensive forms of borrowing–unsecured overdrafts or business credit cards, for example–the difference in the interest rate could be huge.

Your cash flow could also benefit significantly from a longer repayment term, which will have the added bonus of giving you more cash in hand to spend on growing your business. However, be careful: by extending the term of the loan, you’ll hugely increase the total amount of interest you pay, so it’s crucial to weigh the pros and cons.

And of course, we mustn’t forget that if your new loan is larger than the loan it repays, you will have a substantial cash windfall. Investing this money wisely to power your company, while keeping a little back to ensure a smooth cash flow, could be the best business decision you’ve ever made.

What Are the Reasons to Refinance?

First and foremost, you may simply be able to obtain a better deal. In this scenario, your business and its financing needs may not have changed significantly and you could find yourself borrowing a similar or slightly higher amount– but more cheaply.

Alternatively, you might wish to replace one short-term loan with another. However, a word of warning is necessary: it’s very easy to get into a cycle of debt by doing this, even if you save a little on interest by changing providers. In other words, if you’re going to replace a loan with a similar loan, make sure it’s worth the effort and look carefully at other solutions.

In contrast, it could be that your business has changed radically since taking out its last loan. Key milestones include remaining in business for two years (fifty percent of companies fail within five years, so longer-established firms are much more attractive to lenders), generating a six-figure turnover, or reaching a personal credit score of 700 or more. In these circumstances, lenders who previously rejected you could be very interested in taking on your business–meaning you can negotiate far more advantageous terms and save yourself a great deal of cash.

Finally, you might decide to consolidate a number of loans into one more affordable monthly repayment. This will give you access to more capital, simplify your accounting procedures, and hopefully reduce your interest rate, so it’s well worth doing.

Don’t Be Caught by Early Payment Penalties

Before you refinance, you need to bear in mind that many loans carry a penalty for early repayment. This is a way for lenders to make up some of their lost interest if you end the arrangement early, and such penalties can be substantial. Look carefully at all the loans you have and factor in the cost of terminating them before you commit to refinancing. However, if you weigh all the issues carefully, refinancing could be one of the best things you ever do.

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