Small businesses in crisis: Who to pay first when you are low on cash?

In this 5-minute read:

1. Pay the government
2. Pay your employees
3. Pay long-overdue bills
4. Pay utilities and rent
5. Pay suppliers and vendors
6. Pay your secured debts and personal guaranteed debts
7. Pay your insurance
8. Pay larger vs. smaller bills
9. Pay your credit card bills
10. Pay for nonessential services

Cash flow issues are par for the course for most small businesses, and are common even when things are going well. But surprises like a late shipment of key inventory, a government shutdown, a severe weather event, or the latest pandemic can have drastic consequences, over which you have little control.

When things get dicey financially, the smart business owner needs to prioritize who gets paid first and who can perhaps wait a bit. In this article we’ll go over the parties that you should consider paying first, because the consequences of non-payment are the most severe.

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Here’s a list of expenses you should keep paying if at all possible, in order of priority (according to debt.org)

1. Pay the government (taxes, social security, medicare, etc.)

When the chips are down and you need to decide whether to pay the IRS or buy beans, say goodbye to beans for a while. The federal government has zero sense of humor and they consider the funds that you collect for federal payroll taxes, Social Security, Medicare, and state sales/income taxes legally theirs anyway.  

You need to keep these funds separate and “untouchable” for any business use. If you don’t pay your taxes on time, you will be penalized with fines that make it even harder to pay. What’s more, the IRS has the power to garnish your wages, seize funds or property, take money from your retirement account, or even charge you with a crime if you fail to deposit your payroll taxes properly.

So, remember this: if you have to choose ONE party to pay, pay your taxes. Always.

2. Pay your employees (payroll)

It should go without saying that if you don’t pay your employees for work that you agreed to pay them for, bad things happen. In some locales you can be penalized for not paying your employees’ wages on time. In addition, the Fair Labor Standards Act (FLSA) is a federal law that prohibits employers from withholding wages for various reasons, and you may be prosecuted under federal law and/or sued by employees if you don’t pay up.

Another obvious downside of cutting or failing to meet payroll is if you don’t keep your employees happy, they won’t be loyal to you and you will lose them and likely your business. 

You can talk to your staff about necessary pay cuts during difficult financial times, but make sure you adhere to your state’s required minimums and keep communication open. Employees may be somewhat understanding and remain loyal if you treat them like adults and involve them in the conversation. 

3. Pay your overdue bills (Aged Payables)

An aged payable isn’t a bill for your granny’s gambling problem. It’s the term for any bill that is overdue by 2 months or longer. This type of overdue debt can damage your business credit score (not to mention attracting the attention of pesky debt collection agencies).

If your credit score drops, it’s tougher to get business financing, and then there’s the double whammy as these overdue bills get fines and interest penalties added onto them, which of course adds to the debt load. 

So after you’ve paid Uncle Sam and covered payroll, next focus on these high-priority, overdue debt payments. If you don’t have the cash to pay them off in full, contact the creditors and see if you can arrange partial payments, ideally at a lower interest rate. Many organizations are happy to get something rather than nothing (and avoid the added trouble and expense of hiring professional debt collectors).

4. Pay your business rent and utilities

“Keeping the lights on” isn’t just a worn-out business euphemism… it’s necessary. Most likely, you can’t run your business without electrical power and some sort of phone/internet/cable access. And depending on your business structure, you need A/C, water, and all the usual stuff.

If you get behind on your rent, you could potentially get evicted. If you get behind on your water/electricity/gas/phone/internet payments, they can get shut off. Don’t just “go dark” (pun intended) and stop talking to these companies who provide vital services to your business if you can’t pay in full. 

It’s a good idea to talk to them, let them know your situation and plans for reducing debt, and work out a payment plan. Some of them may be inflexible, but some may be open to lowering your rates temporarily, working out a “budget” level of service at a lower price, etc.

Also, if you are critically late with your rent/lease payments, it’s a good idea to try to get a legal forbearance or consult with business experts in your area to find emergency rent assistance if it’s available. Otherwise you could show up for work one morning to find the locks have been changed and the windows boarded up. Bad day.

5. Pay your suppliers and vendors 

If you sell widgets, and you get those widgets from a supplier or vendor, they are not likely to give them to you for free if you fail to pay for them. You depend on your key vendors and suppliers for your business to operate. 

Communicate with your suppliers and vendors and let them know the situation if you’re in a cash-flow crunch. Negotiate a plan for partial payments, reduced inventory, or both. If you have a history of paying your bills on time, your requests for leniency will more likely be met with some agreement.

6. Pay your secured debts and personally guaranteed debts

Owners of sole proprietorships and partnerships are by law personally liable for all business debts. If you have a corporation or Limited Liability Company (LLC), you are only liable for debts that you personally guaranteed. 

Whatever your situation, “secured” debts, or debts that are connected to a specific piece of collateral, real estate, equipment, etc., should be paid on a higher priority basis than “unsecured” debt like credit cards (see below). 

7. Pay your insurance (business liability insurance, other risk coverage insurance)

Ideally, you don’t want to keep your business running for long without liability insurance, but many business owners find themselves letting insurance lapse when times get tough. Again, it’s important to communicate with your agent and try to reduce premiums, adjust your coverage, or raising deductibles to lower your payments. One uninsured liability claim can ruin a business, so try not to operate without coverage for very long.

8. Pay larger bills first, as they hurt you worse if you don’t pay

If you’re to the point where you have some dough to devote to paying off other bills after you’ve dealt with the above, it’s probably a good idea to focus on the larger bills. If you don’t pay bigger bills, it can hurt your credit score worse, as larger debts are weighted more heavily.

Also, if you don’t pay bigger bills, that attracts more attention from the creditors, who may be more likely to report your delinquency to debt collectors and/or credit bureaus. 

This is NOT to say that you should avoid paying smaller bills in favor of larger ones. Ideally you should be communicating with your creditors about your situation and attempting to pay something to everyone you owe. 

Which is better for paying down debt? The “avalanche” or  the “snowball” method?

Here it’s appropriate to discuss which approach is the most effective when choosing where to apply your debt payments first. There are two main methods to tackle paying down debt: the “avalanche” and the “snowball.” 

The “debt avalanche method” is where you pay off your highest-interest debt first, regardless of balance, and when that balance is paid, apply that payment to the next-highest interest rate. The “debt snowball method” is where you pay off your smallest debt first, regardless of interest rate, and gain “momentum” by applying that payment toward the next-smallest debt, and so on.

There are staunch advocates of both of these methods but if you do the math, the debt avalanche makes the most sense mathematically (by a bit). However, if the snowball method makes the most sense to you, go for it. The truth is, if you run the numbers it makes very little difference which method you choose to pay off business debt in the long run.

The important part is to stay motivated and keep paying off your debt.

9. Pay your credit card bills (unsecured debt)

Usually, credit cards are “unsecured” debt (money borrowed without any collateral), which is one reason the interest rates and fees can be so high. (Credit card companies cannot do much—other than adding fees or other monetary penalties—to recover their funds without suing you first and getting a court judgment.)

You should certainly try to keep paying off these bills, but in emergencies they can take a lower priority than the type of debt we’ve listed above. However, those fees and interest penalties we mentioned above can add up quick, and a good business line of credit is often essential for many businesses, so you should try to make the minimum payments if at all possible.  

10. Pay for nonessential, “nice to have” services

After you pay all the above, the last priority for business debt payment is all the stuff you don’t actually need to stay open but is nice to have: cable TV, public WiFi, client entertainment, staff coffee/snacks, dues for professional associations, marketing, “petty cash” (if you happen to even remember what that means), and non-critical facility maintenance and repairs.

Womply can help you get the small business funding that’s right for you

Womply has partnered with various trusted lenders to offer you the best possible rates on small business funding. Whether you need a term loan, a line of credit, or another type of small business capital, we can help!

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