HOW TO MANAGE DEBT IN A COMPANY?

Managing debt in a company is a key aspect of financial strategy. It involves borrowing funds wisely, servicing loans efficiently, and ensuring that debt obligations do not negatively impact the company’s cash flow, profitability, or credit standing. In Pakistan, many businesses rely on a mix of short-term and long-term debt to finance operations, expansion, and capital purchases. However, excessive or poorly managed debt can lead to liquidity crises or default.

Here is a structured guide to how businesses in Pakistan can manage debt responsibly and sustainably.

Evaluate Borrowing Needs

Before borrowing, the business should assess its actual financial requirements. Questions to ask include:

• What is the purpose of borrowing? (e.g., working capital, asset purchase, expansion)

• How much is needed?

• What are the company’s current cash flows and repayment capacity?

This evaluation helps avoid overborrowing, which increases financial risk. It also ensures that the debt taken aligns with the business’s growth objectives and repayment ability.

Choose the Right Type of Debt

Debt should be tailored to the specific need of the business. Common types include:

• Short-term debt: Overdrafts, trade credit, credit lines (used for working capital)

• Long-term debt: Term loans, leasing, bonds (used for fixed assets or expansion)

• Islamic financing options: Murabaha, Ijarah, or Musharakah, offered by Islamic banks in Pakistan

Choosing the right instrument ensures better cash flow alignment and cost control.

Evaluate the Cost of Debt

The cost of debt includes more than just the interest rate. Companies should analyze:

• Interest rate (fixed or floating)

• Processing and legal fees

• Early repayment penalties

• Collateral requirements

Compare different financing offers from banks, leasing companies, and development finance institutions (DFIs) to select the most cost-effective option.

For example, a loan with a 10% annual interest and a 1% processing fee might be less favorable than a loan at 9% interest with no fees.

Monitor Debt Levels

Debt should be monitored using key metrics such as:

• Debt-to-Equity Ratio (Total Debt ÷ Equity)

• Interest Coverage Ratio (EBIT ÷ Interest Expense)

• Current Ratio (Current Assets ÷ Current Liabilities)

Monitoring helps identify when debt becomes excessive. Businesses in Pakistan should ensure their debt-to-equity ratio remains within industry benchmarks and avoid depending on borrowed funds for routine operations.

Use accounting software or ERP systems like QuickBooks, SAP Business One, or Odoo to track outstanding loans, due dates, interest payments, and total liabilities.

Make Timely Payments

Timely repayment of debt is crucial to:

• Maintain a good credit rating with banks and suppliers

• Avoid penalties and late payment fees

• Ensure eligibility for future financing

For example, if your loan EMI is due on the 5th of every month, setting up automatic payments or reminders through accounting software ensures no delay.

Missed payments can negatively impact your credit history with SBP’s e-CIB system, which banks use to assess creditworthiness.

Consider Debt Consolidation

Debt consolidation involves combining multiple loans into a single loan with:

• Lower interest rate

• Longer repayment period

• Easier installment structure

It is useful when:

• The business has multiple high-interest loans

• Cash flow is tight and monthly payments are overwhelming

• You can negotiate better terms with one lender

In Pakistan, some banks and NBFCs offer business debt restructuring and loan consolidation schemes, particularly for SMEs.

Example – Managing a PKR 500,000 Loan

Suppose a company borrows PKR 500,000 from a commercial bank on February 1, 2025, at an interest rate of 10% for 5 years, with monthly payments of PKR 10,417.

Steps to manage the loan:
• Assess borrowing needs and ensure the amount is justifiable
• Choose a 5-year term loan for capital expenditure
• Evaluate cost: 10% interest with a 1.5% processing fee
• Record the loan in the loan ledger
• Make monthly payments on time via auto-debit
• Monitor loan balance every month using accounting software
• Revisit in Year 3 to evaluate consolidation options

Loan Ledger Example:

Best Practices in Debt Management (Pakistan – 2025)

• Prepare a monthly cash flow forecast to ensure you can meet repayment obligations

• Avoid excessive reliance on short-term debt, which can strain working capital

• Use loan amortization calculators to plan repayments

• Maintain good relationships with banks and lenders to access refinancing if needed

• Include all debts in annual audited financial statements for transparency

• Stay compliant with SECP and SBP debt disclosure rules if operating as a company

Tax Implications

• Interest paid on business loans is tax-deductible under Section 20 of the Income Tax Ordinance, 2001, if the loan is used for business purposes

• For companies, proper classification of interest and principal in books is essential for accurate tax filing

• Loans from related parties must comply with arm’s length principles to avoid disallowance of interest expense