[00:00:00] Fi Johnston
The way to pay the debt down is using profit first and sort of setting aside your profit and using that to pay that debt off as aggressively as possible. But it also means that you need to stay within the rest of the income that your business is bringing in. And in order to heal that debt and to stop it from coming again, what you need to do is make sure that you are fully committed to being profitable and spending within your means.
Money Secrets Intro
Are you a small business owner who'd love to be making more money while making positive change in the world? You're in the right place, friend. Hi, I'm Fi Johnston, a chartered accountant and money coach obsessed with small business. In The Money Secrets Podcast, I share strategies that you can use to make more money without working harder. You'll hear successful small business owners share what they've learned about money and business, and I'll help you to think differently and shift your [00:01:00] perspectives about money so you can grow your business and your impact. My mission is to get more money into the hands of good business owners like you.
Acknowledgement of Country
This podcast episode was recorded on the lands of the Wurundjeri people of the Kulin Nation, and I'd like to acknowledge them as the traditional owners and custodians of this land and water that I live, work, and play on. I'd like to pay respects to elders both past and present, and note that sovereignty has never been ceded.
This always was and always will be Aboriginal and Torres Strait Islander land.
Fi
On today's Money Secrets podcast episode, we're gonna talk about something with a capital D, debt. We are going to talk about the different kinds of debt that can exist in a business, how to think about them, how to deal with them, but also how we can use debt to grow our business. [00:02:00] In case this is the first time you've been here, my name is Fi Johnston.
I'm a chartered accountant, I am a business and finance strategist, and I've been working with small business owners just like you for 25 years. I know my way around a profit and loss statement and a balance sheet, and your balance sheet is where your debt shows up in your business. The thing is, most small business owners don't even look at their balance sheet because it's one of those reports that just feels really like, "What the hell am I looking at?"
So what I wanna do is I wanna talk about three different kinds of debt that can exist inside your business. So the first kind of debt is safe debt. This goes with personal debt as well, so this isn't just about business debt. This is the kind of debt where there was a clear transaction, so you purchased a house and there was a mortgage attached, or you purchased another business [00:03:00] and there is an asset there that aligns with the debt that you have borrowed.
It might be that you have borrowed money to buy a piece of equipment. It might be that you borrowed money to upgrade your website. There is an actual asset that belongs to that debt, and you can clearly see, yes, I used the money to purchase this thing, which I at least believed, and hopefully was right, that this thing that I was buying was going to make me more money.
It usually also has a fairly long payment plan, so a mortgage generally has anywhere between 15 and 30 years to pay down the debt, and equipment debt, depends on the equipment. It might be anywhere from five to 15 years, depending on how long the equipment's life might be So that's safe debt. And when we are thinking about this kind of debt, what we wanna do [00:04:00] is look at, okay, over the lifetime of this asset, how much money do I think this asset is either going to make me, or how much money is this asset going to save me?
And that's generally what we're looking at when it's an equipment purchase. So how much is this asset going to make or save me, and how much are the loan repayments, including interest, over the lifetime of the loan going to be? Now we don't just wanna look at the cost of the interest because we also, shock horror, have to actually pay back the principal too.
So that's how we think about good, safe debt. This is the kind of debt that accountants like me are really happy to see on a balance sheet because there's an asset against it, we can see that there was a clear decision made to purchase it, and there's a long-term safe amount of debt in the business to go with it The next type of debt is this kind of middle ground.[00:05:00]
It's a little bit gray. Maybe it was that you found out about a business coach you really wanted to work with, so you took out a $10,000 credit card to pay for that coaching. It's a little bit more risky. We can still see what the transaction was for. We can see that you took out this $10,000 loan to pay for business coaching.
That's a fairly high-risk transaction, depending on the size of your business, of course. If you have a $10 million business, investing $10,000 in coaching is really no big deal, but also you shouldn't need a credit card to be doing that. If your business is 100,000 or 200,000 revenue and you're borrowing $10,000 on a credit card to pay for coaching, you're taking a risk.
You might be taking a calculated risk. You might have already looked at the potential wins that you might get from that coaching. Another example would be a [00:06:00] website. So say for example, a website's going to be $10,000. You know it's going to set you up for success in your business, but it's a risk. We don't ever really know whether a website is actually going to bring us customers, so there's still a risk there.
Another type of this kind of medium level debt is something like a vehicle. Now, some people might say that borrowing money to purchase a vehicle is fairly safe, and I agree, but it's not as safe as an asset that is going to give really long-term value. So with a vehicle, yes, we borrow the money, we pay it down, but the value of that vehicle is decreasing at the same time.
So it's not like you buy a car for $30,000, you pay it off, and it's still worth $30,000. So when we're looking at a vehicle loan, the longer you take to pay it off, the more it costs you because you're paying interest for a longer period of time. So if you are planning on taking out a vehicle [00:07:00] loan, you may like to have a look at what would the repayments be if I paid this off over four, five, six, or seven years?
And then you can actually look at the total amount over the life of that loan to see how much does each of these options actually cost me. So the reason why a vehicle, a website, and coaching are all in this kind of middle ground is because it may provide value to you and it might deliver a return for you, but that is unclear As opposed to in a piece of equipment, which is in the safe category, that you already know is going to reduce your production time by 10 minutes per hour or whatever it might be.
So we've got our safe debt, we've got our medium kind of debt, which is starting to get into a slightly more risky territory. It might also be purchasing a client list from another business. That could end up being a really great [00:08:00] investment, but it's high risk because a client list on its own isn't necessarily going to bring you revenue.
Some people might also consider this kind of debt to be something like purchasing a business that is a little bit new or untested, right? A business that is tested and consistent and has a really consistent profit margin probably sits more in that safe zone, and a business that is a little bit more high risk probably sits in this middle zone.
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Then the third type of debt that exists in a business, and also in our personal lives, is this messy bleed of money where we couldn't say exactly what we spent the money on, but what we know is that we have a $20,000 credit card debt, or we have a $20,000 line of credit, and that $20,000 was made up of 100 different transactions over 10 [00:10:00] years.
The credit card might also have been, you know, 15,000 transactions over however much period. So when we have this kind of debt, it's a symptom that we are spending more than we are making in our business, and it's as simple as that. ATO debt absolutely falls into this category too. So ATO debt is where every quarter the ATO or the Australian Tax Office sends you a, an activity statement and asks you to pay the GST that you have collected on their behalf.
It gives you a credit for the GST that you have paid to other suppliers, and you also need to pay the PAYG, so pay as you go, income tax that you have withheld from the wages of you and your team. So that needs to be paid every quarter. For bigger businesses, that's monthly. But if you're finding that you are [00:11:00] building up an ATO debt, that also falls into this category of kind of unplanned, messy, dangerous kind of debt.
And when I talk about it being dangerous, what I mean is, if we don't stop and look at it and say, "How did I get here?" we are going to keep making that problem worse. So if you have ATO debt You are in very good company because almost every small business owner in Australia has now, or did have in the past, ATO debt.
My understanding is that we owe the ATO something like $2 billion. So this is a really big issue for the Australian Tax Office. So what do we do if we have this kind of messy debt? Now, if it's the ATO, what I would encourage you to do is be really proactive. Do not let it sit there untouched. Call the ATO or get in [00:12:00] contact with your accountant and ask them to contact the ATO on your behalf.
Go into a payment plan if you are able to. That payment plan might be over two years, and in that time, not only do you need to pay back the tax or GST that you owe, but you also need to keep up with your current tax obligations. So when you are thinking about going into a payment plan, you need to consider, can I afford these payments and the future payments that I need to make to the ATO along the way?
So that's how to deal with the ATO. With a credit card or another kind of line of credit or sort of messy kind of debt, what we need to do is identify how it happened. So why are we spending more than we are bringing in? What decisions are we making along the way in our business that's leading us to take on [00:13:00] debt to run our business?
Was it that we took on debt because we made a really m- big mistake? Was it that we were too optimistic about an investment that we were making in Meta Ads, for example? You know, maybe you were so confident that if you spent $50,000 on Meta Ads across six months, that it was going to deliver a huge return, and it didn't.
By the way, if that's what's happening, you need to stop doing Meta Ads and find somebody to help you do them better. But let's say that was what happened to you. It might also be that you had a customer who went bankrupt and didn't pay you. So there can be many things that happen outside of your control And there are many things that are inside your control that lead to having debt in your business.
So in a very general sense, the faster that we pay our debt down, the faster it will be paid off. So the more frequently you make [00:14:00] payments towards a debt, the less interest you will pay over the lifetime of that debt. Now, if your debt is a credit card and you are shuffling between putting things on your credit card, making payments against it, but never quite managing to clear the card back to zero, my advice to you would be to stop using a credit card.
Stop using the credit card, work out how to spend within your means, pay down that credit card, and then learn to live without it Some people just do not have the right kind of temperament to be able to manage a credit card, because it feels like the credit limit is just your money. And when we have that mindset about a credit card, it makes it really easy to spend right up to the limit.
It's also worth considering that it is so easy to spend money. The whole banking system, the whole marketing [00:15:00] industry, it's designed to make it almost effortless for us to spend our money. So if you are finding yourself in this situation where you have a credit card debt, or you have ATO debt, or you've run- rung up a line of credit, or somehow you are unable to pay the bills in your business, there's nothing shameful about this.
It is very normal human behavior. But what we need to do is look at it objectively and say, "How did I get here? How can I stop that from happening in the future? And how am I going to dig myself out of this debt that I'm in now?" So from a really practical sense, I wanna give you a strategy for paying down that kind of debt.
So we're talking about the messy ATO credit card line of credit style debt. So what we wanna do is we wanna put profit first in place in your business. Now, there are other episodes that I've recorded about profit first. [00:16:00] If you haven't listened to them, feel free to go and find them now. I'll give you a very quick overview of Profit First.
So Profit First is a system, kind of like the Barefoot Investor for personal bank accounts, or like the system that all of our grandmothers used, where they divvied out their money into different envelopes. So they had one envelope for groceries, one envelope for rent, one envelope for school fees, and they divvied their money out from their pay into these envelopes to make sure there was always enough for the things that needed to be paid for.
And then if there was anything left over, that could be spent on discretionary things like going out for a meal, or buying a present, or going on a holiday, right? So we can put that same practice into our business using separate bank accounts, and you can pretend the bank accounts are like envelopes, or buckets, or slices of pizza And so going forward from when you set up Profit First, you [00:17:00] decide what percentage is going to go to paying for people, paying for expenses, paying for the ATO, and paying profit.
So once you work these percentages out, you are then going to only spend within those percentage limits. Now, if you have a debt that is really significant, you are probably going to need a much higher percentage going into, say, the ATO bank account, if that's what your debt is, or a higher percentage going into your profit bank account, which you can then use to pay down that debt.
So we need to be realistic about How can I manage my income that comes in now in a way that means I'm not spending more than what is coming in? And then trying to be realistic about, okay, if I've got an idea of how much money is going to come in across the next year. So let's say you're, you think that you're going to have about [00:18:00] $500,000, or let's make it $100,000 just to make the maths easy for me.
So let's say you think there'll be about 100,000 coming in in the next year, and you are going to put 10% of that into your profit account. That gives you $10,000 across the year to use to pay that debt down. So what you wanna do from a practical perspective is you, every week when you transfer money from what has been paid by your customers into your profit account, you wanna then pay almost all of that towards your debt.
So you wanna be paying every single week if possible. If weekly isn't possible, you could do fortnightly, and if fortnightly isn't possible, you could go to monthly. But you will save money by making more regular payments. So while you have debt in your business, the purpose of your profit bank account is to pay down debt.
So let's say you have a $20,000 [00:19:00] debt and you're making about 100,000 a year, essentially using 10% of your profit will should roughly have that debt paid off in two years. And then how awesome is it gonna feel to have 10% of your income now building up in your profit account that doesn't need to be used to pay down debt because you've already cleared it.
So that's the, the sort of win or the goal at the end, or the kind of, you know, light at the... what is it? Pot at the end of the rainbow, which is that once that debt has been paid down, now you've freed up more money in your business. Now, another way of thinking about it would be to say, "Okay, well, this is the position that I've gotten myself into.
I've got a $20,000 ATO debt, and I bring in about 100,000 a year. Clearly, I'm not making enough money to live within this sort of system. So am I spending too much, or do [00:20:00] I actually need to work out how to increase my income?" Because if you could increase your income to 150,000, that would mean you'd have 15,000, 10% of that, to pay towards that debt in the first year.
So you'd only need a year and a bit to pay that $20,000 off if your income was higher So just going back through our three different types of debt. There's safe debt, which is easily linked to an asset. We purchased a home, we purchased equipment, we purchased something of real tangible value that is going to last for a long time, and we borrowed money against that, and it is a safe amount of debt for the size of business that we have.
The second type of debt is this medium debt. This is where you might do something like take out a credit card [00:21:00] to pay for business coaching. Now, side note, I do not recommend doing that. And in fact, if I suspect that one of my new clients is going to need to put my coaching on a credit card, I'm going to recommend that they don't, because putting yourself into credit card debt for coaching is a high-risk activity.
We could talk more about that in a future episode. But this medium type of debt, it's where you've bought a vehicle and it's not really going to have long-term value. You might have bought business coaching, you might have extended a line of credit to purchase some stock from overseas, um, meaning that it comes earlier than if you had to wait to build up that 20,000 in your bank account.
So this kind of debt is in that medium term where we definitely need to have a process to pay it down, but we know exactly how it came to be there, and we are [00:22:00] clear about the decision that we made to spend that money. Then there's this third kind of debt, which is messy, it's unclear, and it's dangerous, and it tends to be at a high interest rate.
This is things like a credit card, a line of credit that you cannot identify where that money went because it went to so many different transactions. It's a credit card where, again, you can't really say exactly how that debt came to be. That kind of debt means that you are spending outside your means or living outside your means.
The only way to repair that kind of debt in your business is to stop spending more than you make The way to pay the debt down is using profit first and deferring or sort of setting aside your profit and using that to pay that debt off as [00:23:00] aggressively as possible. But it also means that you need to stay within the rest of the income that your business is bringing in.
And in order to heal that debt and to stop it from coming again, what you need to do is make sure that you are fully committed to being profitable and spending within your means. I hope that was an interesting way of thinking about the different types of debt that exist in your business and how to deal with them.
I'll see you in the next episode.
Outro
Thank you so much for listening right up to the end. I hope you enjoyed this episode of Money Secrets, where we talk about the money secrets of successful small business owners. If you enjoyed the episode, I'd love it if you'd subscribe to the podcast, could leave us a review, or share this episode with one of your friends.
I hope you learned something. I hope you got a new perspective, and I really hope you enjoyed the [00:24:00] listening experience.
