Bad debt vs good debt: Learn what they are

For many, debt can be intimidating to contemplate however the reality is that accepting the right type of debt could allow your company to grow and thrive. How do you figure out what kind of debt makes business sense? It’s all about considering how long-term value it is likely to bring to your business. What is key is comparing the benefits you expect to accrue from the debt (such as the ability to increase sales) versus the costs of the debt (such as interest and fees), and making sure the former is larger than the latter. As long as you’re using the debt to finance purchases which will boost the efficiency and effectiveness of your business, then there’s no reason to avoid debt. Taking on debt can also assist you in dealing with any unexpected short-term cash flow issues you may encounter. If you’ve run any stock-based business then you’ll know the challenges that short-term cash flow businesses typically face. A partnership with a finance company can help stop any stock-outs, or give you the best deal of your fastest-selling product.

What is good loan?

In simple terms, good debt allows an organization to access capital that they might not otherwise be able to access so that they can increase the returns. Good debt is one that will aid your business in moving to the next step - it could be to buy the most expensive equipment for delivery vehicles, or even debt to help in marketing and advertising. As long as you’ve made a return on that credit (bigger than the cost) the chances are it’s going to be a great debt. For example a skin wound and scar management clinic’s owner took out a small business loan to purchase the salon a new one, remodel the premises and hire a business coach which was deemed to be a good debt. The premises were quite old and dilapidated. I had to bring them up and make it a beautiful space where visitors wanted to be to, where it’s comfortable, relaxing and cozy. The good debt is also used to boost a business’s working capital and ease cash flow issues over tough or slow times like the summer holidays for businesses that specialize in service. The majority of people believe that Christmas is one of the best seasons in the calendar. Unfortunately, as everyone other people are enjoying their holiday the holiday season can turn into the worst business period in the whole year. People pay you late, sales may decline and suppliers would like to be paid.

What is bad debt?

Bad debt, on the other hand it is usually something that is more expensive than what you can get from it. It’s not likely bring in sales, or it’s not going improve your bottom line or not going to boost the overall efficiency or value of your business. For example, under certain circumstances, a new car for your company could be considered a bad loan. If you’re borrowing money to purchase the car will allow you to work harder for more people in more places or it’s a car that you need to have to be able to provide the product you’ve developed, that’s an asset to the business. However, if it’s just a vehicle that you’re buying for the sake of having a brand new corporate car but isn’t providing any value directly to your company, it’s a bad debt.

How to determine the difference between bad and good debt

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

• What amount of money can I make using the money I borrow? What’s the best way to make money?
• What amount of interest and charges will I have to pay on the debt?
• Will I be financially secure in the long run?
• How do I have to wait to achieve this situation?
• Can the money be used in other ways to earn a higher return within a shorter time?
• Am I spending beyond my means?

It is also important to consider the potential benefits that funding will provide, and whether these opportunities will bring an overall benefit to your company. When investing, you have to understand the return you’re earning on your investment. Maybe a new site or shop will draw more customers in or a brand new piece of equipment may bring you a brand new service line and income stream. The most important thing is to budget the return, the repayment timetable and the capacity of your business. If you’re still unsure of the likelihood of finance being a good debt or bad debt for your business, talk to your accountant.