Bad debt vs good debt: How to identify which is which

For many, debt can be intimidating to contemplate But the truth is that taking on the right kind of debt could allow your company to grow and flourish. How can you figure out what debt makes good business sense? It’s all about assessing the long-term value the debt is likely to add to your business. What is key is comparing the benefits you anticipate to gain from borrowing (such as the ability to generate more sales) in comparison to the costs associated with taking on the loan (such as interest and charges) and ensuring the former is larger than the latter. As long as you’re taking on debt for purchases that can improve the performance and efficiency of your company, there’s usually nothing wrong with debt. It can assist you in dealing with any short-term cash flow issues you may have to face. If you’ve ever had the opportunity to run any stock-based business you’ll be aware of the cash flow problems that short-term companies often have to face. A partnership with a finance company can help stop any stock outs or get you the best sale on your top-selling product.

What is good loan?

In essence, good debt allows a business to leverage capital they wouldn’t otherwise be able to access in order to increase the amount of money they earn. Good debt is one which will enable your business to move to the next step - it could be for the purchase of the most expensive equipment such as delivery vehicles, or even to help in marketing and advertising. As long as you’ve got the potential to earn a profit from that credit (bigger than the cost) the chances are it’s going to be a good debt. For example , a wound and scar management clinic’s proprietor took out a tiny business loan to purchase the salon a new one, remodel the premises and hire an experienced business coach. It was considered to be a great debt. The salon was quite old and dismal. I needed to freshen them up and make the perfect place where people would want to visit, where it’s nice, cosy and inviting. It can also be used to increase a business’s working capital and smooth out cash flow problems during difficult or quiet periods, such as the summer months for businesses that specialize in service. For the majority of people, Christmas is among the most enjoyable seasons in the calendar. While everyone else is enjoying themselves this can be the most challenging business period of the year. Customers pay late, sales may decline and suppliers would like to be paid.

What is bad debt?

Bad debt however it is usually something that is more expensive than what you get out of it. So it’s either not going boost sales, it’s unlikely to increase your bottom line or it’s not going to improve your overall productivity or value of your company. For example, under certain circumstances, purchasing a new company car could be a bad credit. If you borrow money to purchase this vehicle will result in you being able to work harder for more people in more places or it’s a car which you’re required to have for the delivery of your product, then that’s an investment in value. However, if it’s just a vehicle that you’re buying for the sake of having a flash new company car but isn’t providing any value directly to your company, it’s an unworthy debt.

How to determine the difference between bad and good debt

When it comes to determining whether the business financing you’re thinking about is a good debt or a bad debt, it’s vital to crunch the numbers. He suggests that you ask yourself these questions:

• How much money can I make from the funds I borrow? What’s my chance?
• What is the amount of interest and other costs will I have to pay to settle the debt?
• Will I be in a good financial position in the long run?
• How do I have to wait to reach that positive situation?
• Can the money be used elsewhere for a better return within a shorter period?
• Are I spending more than my means?

You should also consider the opportunities that investing in additional funds can bring, and if these opportunities will bring positive outcomes for your business. When investing, you need be aware of the returns you’re getting on your money. Maybe a new site or shop will draw more customers in or a new piece of equipment could offer a completely new service line and income stream. The key is to plan the return, the repayment schedule and your capacity. If you’re not sure whether finance will end up being a great debt or bad debt for your business, talk with your accountant.