Floating debt, common for many businesses, is debt such as a bank loan that is consistently refinanced. A primary aspect of the floating debt strategy is that the loan is short-term, which forces the company to constantly refinance near the end of the loan’s period. Short-term debts normally carry a lower interest rate, so businesses can use this to lower their costs. At the same time, if the interest rate increases when businesses refinance, this strategy can end up costing more money than a long-term loan would. Another problem is that businesses with low credit scores may be unable to secure a loan at a crucial time; this also is true if the bank is experiencing problems.
To benefit from floating debt, a business must take out a short-term loan. This loan commonly lasts for a year or two, perhaps less. While the money from this loan can be used for anything, it typically is applied to operating costs and serves to fund the business.
The primary advantage of taking out short-term loans with floating debt is that this normally secures lower interest rates. When compared to long-term loans, short-term loans commonly have lower interest, so the business taking out a loan can reduce its operating expense. To further benefit from this advantage, the business will consistently refinance during times of low interest rates to pay even less.
One major flaw with the floating debt strategy is that interest rates may increase, which can affect the business if it is refinancing or if the interest rate on the loan is variable. While the business may be able to wait on the loan, a business that needs money immediately may have to refinance, even if the interest rate is high. If the interest rate goes too high, then it may eradicate the benefit entirely, especially if short-term rates are higher than long-term rates.
With a floating debt, the business typically does not refinance or get another loan unless necessary. If the business’s credit score is decreasing, or if the bank is going through tough times and is unwilling to give out loans, this can lead to the business being unable to secure a loan for necessary funds. In this case, the business can look for another bank to work with, or the business may have to consider bankruptcy if there are no funds or assets to use for operating costs.