Good debt vs bad debt: How to know what they are

For many they find debt to be daunting to accept However, the truth is that having the right amount of debt can allow your company to grow and flourish. So , how do you figure out what kind of debt is best for business sense? It’s all about looking at the value that the debt is likely to bring to your business. What is key is comparing the benefits you’re hoping to gain from borrowing (such as being able to increase sales) against the cost of borrowing (such as fees and interest) and ensuring that you’re getting more for the latter. If you’re taking on debt to purchase items which will boost the performance and efficiency of your business, then there’s usually nothing wrong with debt. It can help you overcome any unexpected short-term cash flow issues you may encounter. If you have ever run the stock market you’ll be aware of the short-term cash flow issues businesses often face. Working with a financial institution can help stop any stock-outs, or give you access to the bulk sale on your top-selling product.

What is good debt?

In simple terms, good debt allows businesses to access capital that they might not otherwise have access to in order to boost their returns. Good debt is one that will enable your business to move to the next level - it could be to buy a big piece of kit for delivery vehicles, or even debt to help with advertising and marketing. If you’ve earned an income from the loan (bigger than the cost) the chances are it’s going to be a good debt. For instance, a skin wound and scar management clinic’s owner took out a modest business loan to acquire a new salon, renovate the premises and hire a business coach which was deemed to be a good credit. The building was outdated and in need of a makeover. I needed to freshen them up and make it an inviting space that people would want to visit and feel cosy and inviting. It can also be used to increase a business’s working capital, and to smooth out cash flow issues over tough or quiet periods such as the summer holiday season for businesses that specialize in service. For most people, Christmas is among the most wonderful times in the calendar. As everyone else is enjoying their time this can be the worst time for business in the whole year. People pay you late, sales can decline and suppliers would like to be paid.

What is a bad debt?

Bad debt, on the other hand is typically something that is more expensive than what you earn from it. This means that it’s unlikely bring in sales, or it’s unlikely to increase your bottom line, or it’s not likely to increase the overall value or productivity of your company. For example, under certain circumstances, a new company car can be a bad credit. If you borrow money to purchase this vehicle will result in you being able to do more work for many more people at more locations or it’s a car which you’re required to have in order to offer an item, that’s a value-adding vehicle. If it’s simply an automobile you’re purchasing to have an impressive new car for the company and isn’t providing any direct benefit to the business, that’s an unworthy loan.

How can you tell if you are in good debt from bad debt?

When you’re trying to figure out whether the business financing you’re contemplating is an excellent debt or a bad debt, it’s crucial that you analyze the numbers. He suggests that you ask yourself the following questions:

• How much money can I make using the money I borrow? What’s my chance?
• How much interest and costs must I pay on the credit?
• Do I stand in a good financial position in the future?
• How many years will it take to get to that standing?
• The money can be used elsewhere for a better return in a shorter period of time?
• Do I spend more than my means?

Also, you should consider the opportunities that investing in additional funds could provide, and whether they will provide a net benefit for your business. When investing, you have to know the value you’re receiving on your investment. Maybe a new website or your store will attract more customers, or a new piece of equipment could provide you a whole new service line and revenue stream. The key is to prepare the return in advance, as well as the repayment schedule , and your capability. If you’re unsure whether finance will end up as a good or bad debt for your company, talk to your accountant.