Bad debt vs good debt: Learn what they are

For many it can be a daunting task to take on however the reality is that taking on the right type of debt could allow your company to grow and thrive. So how do you work out what debt makes good business sense? It’s about looking at the value that the debt is likely to add to your company. What is key is comparing the benefits that you hope to reap from the debt (such as the ability to sell more) against the cost of borrowing (such as fees and interest) and ensuring you’re getting more for the latter. If you’re using the loan to make purchases that will improve efficiency and productivity in your business, then there’s usually nothing wrong with borrowing. Taking on debt can also assist you in dealing with any sudden cash flow issues that you might encounter. If you’ve ever worked in a stock business, you will understand the challenges that short-term cash flow companies typically have. Working with a financial institution will help you stop any stock sales or grant you access to the biggest offer of your most popular product.

What is good debt?

In most cases, good credit allows a business to borrow capital that they would not otherwise be able to access in order to boost their returns. Good debt is debt that’s going to enable your business to move to the next level - it could be to buy the most expensive equipment such as delivery vehicles, or even debt to help with marketing and advertising. As long as you’ve got some sort of return on the debt (bigger than the expenses) the chances are it’s going to be a decent debt. For example , a wound and scar management clinic’s owner obtained a small business loan to acquire a brand new salon, refurbish the premises and hire an expert business coach. This was considered good credit. The premises were quite old and deteriorated. I wanted to brighten the space and create a beautiful space where people wanted to come in, where it’s warm, relaxing and cozy. Good debt can also be used to increase a business’s working capital, and to smooth out cash flow issues over tough or quiet times for instance, like the summer vacations for businesses that specialize in service. For many, Christmas is one of the most pleasant time of the year. As everyone else is having a blast it can also turn into the most difficult business time that year. Paying customers are late, sales can decrease and suppliers will want to be paid.

What is bad debt?

Bad debt However, bad debt is typically something that costs you more than what you earn from it. So it’s either not going bring in sales, or it’s unlikely to increase your bottom line, or not likely to increase the overall value or productivity of your business. In certain conditions, a new car for your company could be a bad debt. If you borrow money to purchase that vehicle is going to enable you to do more work for many more people at more locations and it’s a vehicle which you’re required to have for the delivery of an item, it’s an asset that adds value to your business. But if it’s just a car you’re buying to have a brand new corporate car but isn’t adding any direct value to the business, that’s a bad debt.

How to determine the difference between bad and good debt

When you’re trying to figure out the possibility that the business finance you’re thinking about is a good debt or a bad debt, it’s vital to crunch the numbers. The expert suggests asking yourself these questions:

• How much can I make using the money I borrow? What’s the best way to make money?
• What amount of interest and charges will I be required to pay for the debt?
• Do I stand in a positive financial position in the future?
• How much time will it take me to achieve this position?
• The money can be used in other ways to earn a higher return within a shorter time?
• Are I spending above my means?

Consider the potential benefits that funding will provide, and whether they will provide an overall benefit to your company. If you are investing, you must to understand the return you’re receiving on your investment. Maybe upgrading your site or shop will draw more customers in or a new piece of equipment may provide you a whole new service line and revenue stream. The main thing is you set a budget for the return, the repayment schedule and your ability. If you’re still unsure of whether the finance you take on will end up being a positive or bad debt to your company, speak to your accountant.