Bad debt vs good debt: How to know which is which

For many people they find debt to be daunting to take on But the truth is that taking on the right type of debt will allow your business to expand and thrive. So , how do you figure out what debt makes good business sense? It’s all about considering the long-term value the debt will likely bring to your business. What’s important is to evaluate the benefits that you hope to gain from borrowing (such as being able to make more sales) versus the costs of the debt (such as interest and fees), and making sure the former is greater than the latter. So long as you’re taking on the debt to purchase items that will improve productivity and performance in your business, then there’s nothing wrong with borrowing. In addition, borrowing money can assist you in dealing with any unexpected short-term cash flow issues you may be facing. If you’ve ever had the opportunity to run any stock-based business and have experienced the issues of cash flow that companies often have to face. Working with a financial institution can help stop any stock outs or get you access to the bulk offer of your most popular product.

What is good credit?

In simple terms, good debt allows businesses to tap into capital they wouldn’t otherwise have access to in order to increase their profits. Good debt is one that’s going to aid your business in moving to the next stage - it can be for buying a big piece of kit, getting delivery vehicles or even to help in marketing and advertising. As long as you’ve got the potential to earn a profit from that loan (bigger than the expenses) the chances are it’s going to be a decent debt. For example , a wound and scar management clinic proprietor took out a tiny business loan to purchase an all-new salon, upgrade the facility and employ an expert business coach. This was considered good credit. The premises were quite old and dismal. I wanted to brighten them up and make the perfect place where people would want to visit and feel cosy and inviting. The good debt is also utilized to boost a company’s working capital as well as smooth the cash flow challenges during challenging or slow periods like the summer vacations for service-based businesses. For most people, Christmas is among the best seasons during the entire year. While everyone else is enjoying themselves it can also turn into the most challenging business period of the year. Customers pay late, sales may drop and suppliers want to be paid.

What is a bad debt?

Bad debt however, is generally something that costs more than you earn from it. It’s not likely increase sales, it’s not going improve your bottom line, or it’s unlikely to enhance the overall value or productivity of your company. For example, under certain circumstances, purchasing a new car for your company could be considered a bad loan. If you borrow money to purchase this vehicle will lead to you being able to provide more services to more people in more places, or it’s a vehicle which you’re required to have to be able to provide products, it’s an asset that adds value to your business. If it’s simply a car you’re buying in the interest of having a flash new company car and isn’t adding any direct value to the business, that’s a bad credit.

How to distinguish good debt vs bad debt

When you’re trying to figure out the possibility that the business finance you’re contemplating is a good or bad debt, it’s crucial to crunch the numbers. He suggests that you ask yourself these questions:

• What is the maximum amount I can make using the money I’ve borrowed? What’s my chance?
• How much interest and costs will I have to cover on the loan?
• Do I stand in a better financial position in the future?
• How much time will it take me to reach that positive situation?
• Could the money be utilized elsewhere for a better return within a shorter amount of time?
• Am I spending beyond my means?

You should also consider the potential benefits that funding will provide, and whether these opportunities will bring positive outcomes for your company. When investing, you need be aware of the returns you’re getting from your investment. Maybe a new site or shop will draw more customers in or a brand new piece of equipment may give you a new revenue stream. The key is to budget the return, the repayment plan and the capacity of your business. If you’re still unsure of whether the finance you take on will end up being a positive or bad for your business, talk to your accountant.