You can fund a business either through cash or through a loan. Cash simply means having the available money to, while a loan is a debt you have to pay back in the future. Any loan comes with interest and whilst it would be great not to have any loan or debt to pay, sometimes it’s a smart move in building your business.
We can classify debt in to “good debt” or “bad debt”.
What is Good Debt?
A debt is said to be “good” if it helps you build your assets or is an investment which will pay off in the future. If you spent the debt on the business for it to generate an increase in revenue or for the business to grow in value in the future, that’s a good debt. Examples of this could be purchasing commercial premises for your business.
The purchase of real estate through borrowed money is often considered to be good debt because the property’s value will appreciate over time. If debt was used on purchasing an investment property, there is a potential to generate rental income by leasing the property out and there could also be tax deductions available.
Essentially, good debt is an investment geared towards generating income.
What is Bad Debt?
The opposite of a good debt is a bad debt, where the use of borrowed money in purchasing assets or items that immediately depreciate or lose value.
For example, borrowing on a high interest credit card to purchase a new sofa for the reception area of your business. Whilst it makes the surrounds nicer for your visitors, it won’t increase the production capacity or income in your business, and it immediately depreciates in value the minute it’s left the showroom floor.
Should I just avoid debt altogether?
Very few people have the cash to fund their businesses outright. Borrowing for your business can be a good thing providing it’s linked to the generation of income and the interest rate is not too high. Using a credit card to help with cash flow only becomes bad debt when you can’t pay it in full when it’s due.
Reminders about debt
Know your goals – when you are looking to borrow money, make sure it’s for the right reasons.
Know your limits – you’ll know when debt is about to become bad if you know you no longer have the capacity to pay for it. Whilst growth is good for any business, ensure you have the capacity to pay off whatever debt you incur.
Need help in determining whether borrowing money can be good in growing your business? Give us a call and we’ll be happy to help.