Good debt vs bad debt: How to identify which is which

For many people it can be a daunting task to accept however the reality is that having the right amount of debt can allow your company to grow and flourish. How can you figure out which debt is good business sense? It’s all about assessing the value that the debt is likely to add to your company. What is key is comparing the benefits that you hope to gain from borrowing (such as being able to sell more) in comparison to the costs associated with the debt (such as fees and interest) and ensuring the former is larger than the latter. If you’re using the loan for purchases that are going to drive productivity and performance in your company, there’s nothing wrong with the use of debt. The use of debt can assist in the resolution of any cash flow issues you could be facing. If you’ve ever worked in a stock business, you will understand the short-term cash flow issues companies often have to face. Working with a financial institution will help you stop any stock-outs, or give you the best discount of your product that is the fastest-selling.

What is good debt?

In the end, good debt permits businesses to leverage capital they wouldn’t otherwise be able to access in order to increase their profits. Good debt is one that can enable your business to move to the next stage - it could be to buy an enormous piece of equipment for delivery vehicles, or even debt to help with advertising and marketing. If you’ve earned some sort of return on the credit (bigger than the cost) the chances are it’s going to be a good debt. As an example, a skin abrasion and scar management clinic owner obtained a small business loan to buy an all-new salon, upgrade the facility and employ a business coach which was considered good credit. The salon was quite old and dilapidated. I wanted to brighten them up and make a beautiful space where people would want to visit, where it’s nice, relaxing and cozy. The good debt is also employed to improve a company’s working capital and smooth out the cash flow challenges during challenging or quiet times, such as the summer holidays for businesses that are service-based. The majority of people believe that Christmas is one of the most wonderful times in the calendar. While everyone else is enjoying themselves this can be the worst business period that year. People pay you late, sales may fall, and suppliers are eager to be paid.

What is a bad debt?

Bad debt however typically is more expensive than what you earn from it. This means that it’s unlikely bring in sales, or it’s not going to improve your bottom line, or it’s not going to boost your overall productivity or value of your company. For instance, in certain conditions, a brand new company car can be a bad debt. If you’re borrowing money to purchase the car will enable you to do more work for many more people at more locations or is a vehicle that you need to have in order to offer an item, it’s an asset to the business. But if it’s just a car you’re buying for the sake of having an impressive new car for the company but isn’t providing any value directly to the business, that’s a bad credit.

How do you determine whether you have good debt from bad debt?

In order to determine whether the business finance you’re contemplating is a good or bad debt, it’s vital that you crunch the numbers. It is recommended to ask yourself these questions:

• How much money can I make from the funds I’ve borrowed? What’s the opportunity?
• How much interest and cost will I have to cover to settle the debt?
• Are I in a better financial position in the future?
• How much time will it take me to achieve that positive standing?
• Could the money be utilized elsewhere for a better return in a shorter period of time?
• Do I spend more than my means?

Consider the opportunities that extra funding could provide, and whether those opportunities will result in positive outcomes for your business. If you are investing, you must to know the value you’re receiving on your investment. Maybe upgrading your website or your shop can increase the number of customers you have or a new piece of equipment can bring you a brand new service line and revenue stream. It is important to set a budget for the return, the repayment plan and your capability. If you’re still uncertain the likelihood of finance as a good or bad for your business, speak to your accountant.