How do you deal with debts in a small business? A question that is frequently asked by new Profit First users is this, what debts should be paid off first? There is an argument to be made for paying down fastest on the debt with the highest interest rate. But, assuming that all your debts have similar rates, there is a better choice. It is to pay the smallest first. Why is that?
Reinforcing Good Habits
A basic part of why Profit First is so successful is that this method is “self-reinforcing.” That is to say, we reward ourselves for doing the right thing! In the case of paying off debts, the Profit First method is to pay all required minimums of all debts out of the operating account, as well as all of the bills for the month. Then use the extra to pay on the smallest debt. Because this is the smallest debt, it will take less time to reduce the balance and finally pay it off. The reward for your “behavior” in paying off debts this way is that you owe less and you feel a lot better about yourself and your business. This approach is similar to what happen when we put money into the Profit Account on the tenth and twenty-fifth. We see the results and feel good about it. That encourages us to continue to use the business practice that is showing results.
Once you have paid off the first and smallest debt, start on the next smallest one. At this point, the arithmetic is on your side. You can put everything that you used to pay off the first debt toward the next smallest, not only does the minimum get smaller for that next-smallest debt,but the balance falls and you are seeing tangible success. As this process continues, you have fewer minimum payments to deal with, so your payments toward paying off debts will “snowball,” increasing with each successive debt you are working to reduce and pay off. In fact, the debt-snowball method is a tried and true way to reduce debts.
How to Do It
Start by listing all of your debts in order from the smallest to the largest. The only adjustment to this list is when two debts are for almost the same amount, list the one with the higher interest rate first.
The next step is basic. You need to commit to pay the minimum on each and every debt each and every month.
Then you will decide how much money is available to pay every month towards reducing the smallest debt.
Start paying minimums and paying principle on the smallest debt.
NOTE: You may need to contact the lender to make sure they apply the extra each month toward the principle on your debt as otherwise they may simply apply it to the next payment. Credit card companies typically do this but on car loans or your home mortgage you probably should talk to them first.
Once the first debt is paid off apply the minimum and the payments you were making to the next smaller loan.
Continue this process until all debts are paid off.
When Something Works We Tend to Do It Again
The Profit First method is designed for success. And, it is designed to show us success early and to reinforce the positive actions that we take in achieving positive results.
If you still have questions or are interested in implementing Profit First in your business schedule a meeting with a Certified Profit First Professional today!