When handled properly, debt consolidation can provide significant assistance in avoiding a crushing debt load. By consolidating a number of different loans, interest rates can be reduced. Convenience is another major draw of consolidation loans. Rather than pay numerous creditors who are charging varied interest rates at different times of the month, you can take out one loan and pay off all of your accounts.
Prior to exploring the possibility of securing a consolidated loan, however, it is important to evaluate your financial position with the help of a CPA. “The first and most critical thing is to have clean and accurate financial statements in order to make a rational decision,” says Rodney Fingleson, chairman of Gumbiner Savett Inc.
Smart Business spoke with Fingleson about debt consolidation, the importance of clean financial statements and what type of debt-to-equity ratio lenders want.
How does the debt consolidation process work?
It is generally a transfer of loans from different lending institutions to consolidate into one particular loan. Many of our clients have their charge cards as liabilities on their corporate balance sheets. They use their American Express, Visa or Mastercard; they use every kind of loan possible to finance their operation. This is extremely expensive, so what we try to do is take all of these loans, bundle them up into one package and have a financial institution consolidate the loan at a much lower rate, provided the company is making a profit.
What are the pros and cons of debt consolidation?
The biggest pro is that you can consolidate to a much cheaper rate. For example, many business owners have debt that is responsible for a whole slew of interest charges. Consolidation will generally eliminate those high charges into a much lower amount. Another pro is that a move toward consolidation helps to save bookkeepers time; rather than spending hours and hours each month reconciling every single account, they can get financial statements to the owners much quicker.
The con is that you have to be careful of the promises that are made to you by debt consolidation companies. It is important to find out which ones are the true lenders. Oftentimes, people get caught up with introductory rates to change their debt and find out much later on that they are in a worse position. One has to watch out for these hard money loans and people who promise to take care of everything when, in reality, the situation only becomes worse.
What factors should be considered when evaluating whether or not to consolidate debt?
The most important thing is that you have to have clean financial statements in order to make a decision. If the books and records of a company are not updated, it is very difficult to analyze a full balance sheet. It is crucial to have up-to-date financials in order to make a proper decision as to when to consolidate and when not to consolidate.
How often should financial records be updated and what specific components are lenders most interested in?
Monthly financial statements should be done between two to three weeks after the month ends. Financial institutions are looking at current ratios and debt ratios to see how a company is performing. Their main concern is debt to equity and whether the company is highly leveraged in the debt area.
Generally, banks are looking at a 5-to-1 or less debt-to-equity ratio. When you cross over this ratio, banks get highly nervous. A great company will have approximately a 3-1 ratio. If the leverage becomes higher than 5-to-1, you will have a rea problem especially in today’s lending market to try and consolidate your debt. A company with a ratio greater than 5-to-1 will pay a much higher rate of interest. The risk factor to the lender is much higher so, in order to bring down your interest charge, it is important to reduce your debt-to-equity ratio.
How should one conduct a search for a firm that specializes in debt consolidation?
The most important thing is to ask your CPA to analyze your balance sheet so he or she can provide you with some answers. Accountants should be aware of the potential benefits that can be derived from debt consolidation and let their clients know on a monthly basis if it makes sense for them.
At our firm, we have clients fax us their monthly financial statements so we can review them and see if there is anything that stands out. If we see anything out of the ordinary or out of balance, we call the client. It is very important to be proactive, and the best person to help you do this is your CPA.
RODNEY FINGLESON is chairman of Gumbiner Savett Inc. Reach him at (800) 989-9798 or firstname.lastname@example.org.