After a short pause, we thought it necessary to kickstart out financial management for farmers and Agripreneurs with debt management, which is a pain point for most of us, especially given the economic conditions and the ever-increasing interest rates.
So, the question is how do we sustainably manage our debt, to ensure that there are no interruptions to the farming business process?
There are a few methods of debt management, however, before we dive into that, we need to reiterate how Cash is King, hence the importance of managing cash flow and ensuring you have money available for operations and meeting the business obligations.
How do we deal with finances and ensure that we sustainably manage the cash flow, there are a few approaches we can use in debt management with an example of two specific methods on how to pay off your debt: the Snowball or the Avalanche method.
These are the two common debt-paying-off approaches.
The debt snowball approach comprises listing all your debt in the order of lowest to highest value, in terms of the balance outstanding to date, while the debt avalanche approach does not necessarily consider the value of the debt but the value of interest, which means you list your debt in order of the highest interest-bearing debt to the lowest-bearing debt.
As we know, interest rate has an impact on how soon one can settle or pay off debt.
With the Snowball approach, you make sure to pay all your debt but with the main emphasis on the first one, with an option to perhaps increase or double the instalment, while paying the minimum on the rest.
Once you are done with the first debt and you have closed it off, you use that instalment to add on the next debt in line, ultimately increasing its instalment again, so you continue until you have paid off all your debt.
With the avalanche approach, you pay the debt with the highest interest first as a priority, but the principle of increasing or doubling the instalment on the first debt in line and then taking that instalment balance to the second debt in line until you are done is similar to the snowball methodology.
Always pay extra on the first debt in line and continue all the way down until you are done.
Below is an example of how it works in real terms.
To give you an example, let us assume you have the following debts:
1. Student Loan: N$30 000 (6% interest rate)
2. Credit Card: N$5 000 (19% interest rate)
3. Personal Loan: N$10 000 (17% interest rate)
4. Car Loan: N$90 000 (11% interest rate)
5. Mortgage: N$800 000 (12% interest rate)
The Debt Snowball Method will list a debt in the following order:
Step 1: Pay off Credit Card (N$5 000)
Step 2: Pay off Personal Loan (N$10 000)
Step 3: Pay off Student Loan (N$30 000)
Step 4: Pay off Car Loan (N$90 000)
Step 5: Pay off Mortgage (N$800 000)
While the Debt Avalanche Method will list debt in the below order.
Step 1: Pay off Credit Card: N$5 000 (19% interest rate)
Step 2: Personal Loan: N$10 000 (17% interest rate)
Step 3: Pay off Mortgage: N$800 000 (12% interest rate)
Step 4: Pay off Car Loan: N$90 000 (11% interest rate)
Step 5: Pay off Student Loan: N$30 000 (6% interest rate)
The other option to consider is to pay off the debt with the highest instalment per month, for you to improve your liquidity. The choice of which approach between the debt snowball and debt avalanche depends on you and your financial state and perhaps what makes more sense for you.
What is important to note is that the debt snowball approach may provide you with psychological motivation, as you gain small wins when you settle your small accounts, On the other hand debt avalanche approach may save you more money over time in interest payments.
*Disclaimer: These are just exemplary numbers, your debt details may look different but be sure to understand the interest rate, monthly instalments, and balances outstanding on your debt on a monthly basis, as this changes.
*Mekupi Kambatuku is a Managing Consultant at Simpli Business Advisory and can be reached at email@example.com.