Bad debt vs good debt: How to know what they are

For many, debt can be intimidating to accept, but the reality is that accepting the right type of debt could allow your business to grow and flourish. So how do you work out what debt makes good business sense? It’s about looking at the long-term value of the debt will bring to your business. The most important thing to consider is the benefits that you hope to gain from borrowing (such as the ability to increase sales) in comparison to the costs associated with this debt (such as fees and interest), and making sure you’re getting more for the latter. As long as you’re taking on debt to purchase items which will boost the efficiency and effectiveness of your business, then there’s nothing wrong with debt. The use of debt can assist you in dealing with any unexpected short-term cash flow issues you could encounter. If you have ever run a stock business and have experienced the cash flow problems that short-term companies typically have. By partnering with a financing provider, you can help stop any stock-outs, or give access to the largest offer of your most popular product.

What is good debt?

In essence, good debt allows a business to leverage capital they wouldn’t otherwise have access to in order to increase the returns. Good debt is one that’s going to aid your business in moving to the next step - it could be for the purchase of an expensive piece of equipment, getting delivery vehicles or even loans to assist with marketing and advertising. As long as you’ve made a return on that loan (bigger than the costs) the chances are it’s going to be a great debt. For instance, a skin wound and scar management clinic proprietor took out a tiny business loan to acquire a new salon, renovate the premises , and also hire an experienced business coach. It was deemed to be a good credit. The building was old and dismal. I needed to freshen them up and make it an attractive space where people were eager to go to, where it’s comfortable, relaxing and cozy. The good debt is also used to boost a business’s working capital, and to smooth out cash flow issues during tough or slow periods such as the summer holidays for service-based businesses. For the majority of people, Christmas is one of the most enjoyable seasons in the calendar. While everyone else is having a blast it can also turn into the most challenging business period in the whole year. People pay you late, sales may fall, and suppliers are eager to be paid.

What is a bad credit?

Bad debt, on the other hand, is generally something that is more expensive than what you earn from it. Therefore, it’s likely not to drive sales, it’s not going improve your bottom line or it’s not going to boost the overall value or productivity of your company. For example, under certain circumstances, purchasing a new car for your company could be a bad credit. If you’re borrowing money for the vehicle will result in you being able to work harder for greater numbers of people in more locations or is a vehicle that you require to be able to provide products, that’s an asset that adds value to your business. But if it’s just a car you’re buying for the sake of having a brand new corporate car, and it’s not really providing any direct benefit to your business, then it’s an unworthy debt.

How to distinguish the difference between bad and good debt

When it comes to determining what business financing you’re contemplating is an acceptable debt or a bad debt, it’s vital to crunch the numbers. The expert suggests asking yourself these questions:

• How much can I make from the funds I borrow? What’s the opportunity?
• What amount of interest and charges will I have to pay to settle the debt?
• Do I stand in a positive financial position in the future?
• How do I have to wait to reach that positive standing?
• Can the money be used elsewhere for a better return in a shorter period of time?
• Am I spending beyond my means?

Consider the opportunities that investing in additional funds will provide, and whether those opportunities will result in an overall benefit to your company. When investing, you have be aware of the returns you’re earning on your investment. Maybe a new site or shop will attract more customers or a new piece or piece of equipment could provide you a whole new service line and revenue stream. It is important to set a budget for the return, the repayment schedule , and the capacity of your business. If you’re still unsure of the likelihood of finance being a positive or bad for your business, speak with your accountant.