“Debt in a professional firm is bad” and “we are proud of achieving our objective of never being in debt” are phrases that you often hear. But is debt really that evil?
All businesses need funding. In most professional practices this is to support the working capital (the fact that you pay your staff and suppliers faster than clients pay you) and you spend money on IT equipment, furniture and office refurbishment. Your choices are to borrow from your partners, by either retaining funds from them or asking them to take out capital loans personally. Alternatively you can obtain debt funding from an external source, such as a bank.
There is nothing in principle that is wrong with the latter. Indeed, anyone who studied A level Economics will recall that there are theoretical models that can tell you the optimal amount of equity versus debt in any business, which listed and private companies regularly follow.
Where debt can be problematic is as follows. Firstly, the structure of the debt should match its purpose. No firm should use an overdraft to provide a permanent level of funding for the firm. Ask yourself how often your overdraft ever goes into credit? Secondly, the debt must be affordable. The actual size of the debt is less important, although obviously you will have to pay it back eventually. What really matters is the firm's ability to cover the funding cost both now and in the future (if the interest rate is not fixed).
So if debt can be good for a professional practice, how can you work out whether it is good for your firm. Most firms these days produce annual budgets. However, less produce resulting cash flow forecasts, less of these produce them on a rolling basis and even less produce cash flow forecasts for a period in excess of 12 months.
If you plan to have a business that exists for more than the next 12 months, I would suggest that you should have a cash flow model that does the same. It doesn't need to be complicated or costly to run and I would be delighted to show you how to set one up.
“Creditors have better memories than debtors”
Benjamin Franklin (1706 - 1790)
Giles Murphy is Head of Professional Practices Group at Smith and Williamson