Here’s what you should know about good vs bad business debt
Society has taught most to believe that any debt should be perceived as “bad debt”. Similarly, in business, taking out a loan or owing someone money may sometimes be viewed negatively.
It goes without saying that when loans are used poorly, debt could irreparably harm your business.
In some instances, established companies and reputed entrepreneurs have plenty to gain by taking on some debt. According to USA Today, the average small business owner has approximately 195,000 US dollars worth of debt.
There’s a reason why the saying “it takes money to make money” is as common as it is. “Good debt” can help your small business generate income –– if planned strategically. Understanding the difference can be an excellent resource to grow your company.
Debt is a necessary part of any business journey. By taking loans or seeking financing, you’re giving your company the fuel it needs to grow.
At the heart of identifying the differences between good and bad debt are a business owner’s aims. While it may sound obvious, it’s important to only take on debt to accomplish goals, spur your company forward or provide the necessary fuel to build the business.
A good barometer to judge whether you can afford to take on debt includes taking a stock whether you may be in a position to pay off the loan on time or early as it can help you save on interests rates.
When should you consider taking on business debt?
The simplest answer would be if it can help build wealth or increase your income over time.
Ever so often, small business owners are presented with business opportunities that are too good to pass up – even if they can’t afford it. Sometimes, the initial set-up costs are too much to bear. However, if due diligence proves that the ROI in the opportunity outweighs the cost of the loan, this would be the perfect time to take the leap.
In such instances, business owners should be mindful when looking at multiple loan offers to ensure they secure the best deal in the market.
Another good reason to get a loan is if it will help business owners increase their working capital. Many companies, regardless of size, resort to accruing debt while waiting for long-term financing or an acquirer. These finances often cover expenses such as utility bills, payroll, rent, and inventory.
Sometimes businesses need this capital to expand their operations – especially when the timing is right economy-wise. How do most businesses avoid plateau? By expanding when profits are booming.
When should you decide against taking on business debt?
The answer to this is much shorter: Basically anything the depreciates in value once purchased. Payday loans for example, is when borrowers receive a cash advance plus a fee, at a very high interest rate.
If the full amount is not repaid when it’s due, the loan “rolls over” and incurs yet another processing fee. It’s these loans that serve as a very common example of how debt can very quickly spiral out of control and cost a business its financial security and credibility.
How can you upskill yourself to make the right decision?
Don’t rely on learning from your failures. Savvy business people work to educate themselves. This doesn’t always mean going back to school. There are many free educational courses available online to upskill in areas such as financial management, for instance.
Coursera hosts a suite of these programmes, typically offered by globally-renowned institutions. Some top picks include: Finance for Non-Finance Professionals by Rice University, Introduction to Finance: The Basics by the University of Illinois at Urbana-Champaign, Think Like a CFO by IESE Business School, or the Managerial Accounting Fundamentals programme by the University of Virginia.