Good debt vs bad debt: Learn which is which

For many, debt can be intimidating to take on, but the reality is that having the right amount of debt could allow your company to grow and prosper. How do you figure out which debt is good business sense? It’s all about considering how long-term value it will bring to your business. What’s important is to evaluate the benefits you expect to reap from the debt (such as the ability to increase sales) against the cost of the debt (such as fees and interest) and ensuring that you’re getting more for the latter. So long as you’re using the loan to finance purchases that can improve efficiency and productivity in your business, then there’s no reason to avoid the use of debt. Taking on debt can also assist in the resolution of any short-term cash flow issues you may confront. If you’ve ever worked in an investment company you’ll be aware of the issues of cash flow that businesses often face. By partnering with a financing provider, you can ease the burden of any stock outs or get access to the largest offer of your most popular product.

What is good debt?

In essence, good debt allows businesses to borrow capital that they would not otherwise be able to access in order to boost their profits. Good debt is debt that will aid your business in moving to the next stage - it could be used to purchase a big piece of kit, getting delivery vehicles or even debt to help with advertising and marketing. If you’ve earned a return on that credit (bigger than the amount you incurred) then it’s likely to be a decent debt. As an example, a skin abrasion and scar management clinic owner took out a modest business loan to acquire a brand new salon, refurbish the premises , and also hire an executive coach, which was considered to be a great credit. The building was old and dilapidated. I wanted to clean them up and make it a beautiful space where visitors wanted to be in, where it’s warm, cozy and welcoming. The good debt is also utilized to boost a company’s working capital and smooth out cash flow issues during tough or quiet times, such as the summer holidays for businesses that are service-based. For most people, Christmas is among the most enjoyable occasions of the year. Unfortunately, as everyone else is having a blast it can also turn into the worst business period that year. When people pay you on time, sales might decline and suppliers would like to be paid.

What is a bad debt?

Bad debt On the other hand, is generally something that will cost you more than the benefits you can get from it. This means that it’s unlikely to drive sales, it’s not going to improve your bottom line, or unlikely to enhance your overall productivity or value of your company. In certain circumstances, a new company car can be a bad credit. If you borrow money to purchase this vehicle will result in you being able to work harder for many more people at more locations, or it’s a vehicle that you need to have to be able to provide products, it’s a value-adding vehicle. However, if it’s just a vehicle that you’re buying for the sake of having an impressive new car for the company but isn’t providing any value directly to your business, then it’s an unworthy credit.

How to determine the difference between bad and good debt

When it comes to determining the possibility that the business finance you’re looking at is a good debt or a bad debt, it’s vital to calculate the numbers. He suggests that you ask yourself these questions:

• How much money can I make from the funds I borrow? What’s the chance?
• How much interest and cost will I have to cover on the debt?
• Do I stand in a good financial position in the long run?
• How long will it take me to reach that positive position?
• The money can be used to purchase other products for better returns within a shorter time?
• Are I spending above my means?

Consider the opportunities that investing in additional funds will provide, and whether these opportunities will bring positive outcomes for your company. When investing, you need to know the value you’re getting from your investment. Maybe a new web site or store can increase the number of customers you have, or a new piece or piece of equipment could offer a completely new service line and income stream. It is important to plan the return, the repayment schedule and your ability. If you’re still uncertain the likelihood of finance being a positive or bad debt for your business, speak with your accountant.