Bad debt vs good debt: Learn what they are

For many, debt can be intimidating to accept But the truth is that accepting the right type of debt will allow your business to grow and thrive. How do you figure out what kind of debt is best for business sense? It’s all about considering the value that the debt will likely bring to your business. What’s important is to evaluate the benefits you anticipate to gain from borrowing (such as the ability to increase sales) as well as the expenses associated with this debt (such as interest and fees) and ensuring that the former is more than the latter. As long as you’re using the loan to make purchases that will improve the efficiency and effectiveness of your business, then there’s no reason to avoid the use of debt. Taking on debt can also assist in the resolution of any sudden cash flow issues that you might have to face. If you’ve ever worked in an investment company then you’ll know the issues of cash flow that companies typically have. Working with a financial institution will help you stop any stock sales or grant access to the largest discount of your product that is the fastest-selling.

What is good debt?

In the end, good debt permits an organization to leverage capital they wouldn’t otherwise have access to so that they can increase the amount of money they earn. Good debt is one that’s going to assist your company in moving to the next step - it could be to buy an expensive piece of 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 amount you incurred) then it’s likely to be a great debt. As an example, a skin abrasion and scar management clinic’s proprietor took out a tiny business loan to acquire a brand new salon, refurbish the facility and employ an experienced business coach. It was deemed to be a good credit. The location was rather old and dismal. I needed to freshen them up and make it the perfect place where people were eager to go to, where it’s comfortable, cozy and welcoming. The good debt is also employed to improve a company’s working capital and smooth out cash flow problems during difficult or quiet times like the summer holiday season for businesses that specialize in service. The majority of people believe that Christmas is among the most wonderful time for the whole year. However, when everyone else is enjoying themselves, it often turns into the worst business period in the whole year. People pay you late, sales can fall, and suppliers are eager to be paid.

What is bad debt?

Bad debt however typically costs you more than what you earn from it. Therefore, it’s likely not bring in sales, or it’s not likely to boost your bottom line, or unlikely to enhance the overall value or productivity of your business. For instance, in certain circumstances, a new company car could be considered a bad debt. If you borrow money to purchase that vehicle is going to result in you being able to provide more services to the greater number of people across more places or it’s a car that you must have for the delivery of products, it’s an asset that adds value to your business. If it’s simply the kind of vehicle you buy in the interest of having an impressive new car for the company but isn’t providing any value directly to the business, that’s a bad loan.

How to distinguish good debt vs bad debt

In order to determine whether the business finance you’re looking at is an acceptable debt or a bad debt, it’s crucial that you analyze the numbers. The expert suggests asking yourself the following questions:

• What is the maximum amount I can earn from the money I borrow? What’s the opportunity?
• How much interest and costs will I have to pay on the amount of debt?
• Will I be in a positive financial position in the future?
• How do I have to wait to get to that place?
• Can the money be used in other ways to earn a higher return in a shorter period of time?
• Are I spending more than my budget?

Also, you should consider the possibilities that additional funding could provide, and whether these opportunities will bring positive outcomes for your business. When investing, you have to know the value you’re receiving on your investment. Maybe upgrading your website or your shop can attract more customers, or a new piece of equipment could offer a completely new income stream. It is important to plan the return, the repayment schedule and the capacity of your business. If you’re still unsure of whether the finance you take on will end up as a good or a bad debt for your company, talk to your accountant.