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

For many the idea of debt is daunting to consider But the truth is that taking on the right kind of debt can allow your business to grow and grow. How can you figure out what kind of debt makes business sense? It’s all about considering how long-term value it will likely bring to your company. What’s important is to evaluate the benefits you expect to receive from the debt (such as being able to generate more sales) as well as the expenses associated with the debt (such as interest and charges) and ensuring the former is greater than the latter. If you’re using the debt for purchases which will boost the efficiency and effectiveness of your business, then there’s no reason to avoid borrowing. In addition, borrowing money can assist you in dealing with any sudden cash flow problems you might have to face. If you have ever run a stock business, you will understand the cash flow problems that short-term companies typically have. By partnering with a financing provider, you can ease the burden of any stock sales or grant access to the largest discount of your product that is the fastest-selling.

What is good credit?

In simple terms, good debt allows an organization to leverage capital they wouldn’t otherwise be able to access so that they can increase the returns. Good debt is one that will enable your business to move to the next level - it could be for the purchase of a big piece of kit, getting delivery vehicles or even to help with advertising and marketing. As long as you’ve got an income from the credit (bigger than the cost) that’s usually going to be a great debt. For example a skin wound and scar management clinic’s proprietor took out a tiny business loan to acquire a brand new salon, refurbish the premises , and also hire a business coach which was considered to be a great credit. The building was old and dismal. I wanted to clean them up and make a beautiful space where visitors wanted to be in, where it’s warm, cosy and inviting. Good debt can also be employed to improve a company’s working capital as well as smooth the cash flow challenges during challenging or slow periods, such as the summer holiday season for companies that provide services. For the majority of people, Christmas is one of the most wonderful seasons in the calendar. As everyone else is enjoying themselves this can be the worst time for business of the year. When people pay you on time, sales might drop and suppliers want to be paid.

What is a bad credit?

Bad debt however, is generally something that costs you more than what you can get from it. This means that it’s unlikely boost sales, it’s not going to improve your bottom line, or it’s not likely to increase your overall productivity or value of your business. For instance, in certain circumstances, purchasing a company vehicle that is new could be considered a bad debt. If you’re borrowing money for this vehicle will enable you to perform more work for greater numbers of people in more locations or it’s a car that you require in order to deliver the product you’ve developed, that’s an investment in value. However, if it’s just the kind of vehicle you buy just to get a flash new company car, and it’s not really contributing any tangible value to your company, it’s a bad debt.

How to determine the difference between good and bad debt

In order to determine what business financing you’re looking at is a good debt or a bad debt, it’s crucial to calculate the numbers. It is recommended to ask yourself the following questions:

• How much can I make using the money I’ve borrowed? What’s the best way to make money?
• What amount of interest and charges will I have to pay to settle the loan?
• Will I be in a good financial position in the future?
• How long will it take me to achieve that positive position?
• Can the funds be put to use elsewhere to get a higher return within a shorter amount of time?
• Are I spending more than my budget?

Consider the potential benefits that funding can provide, and whether these opportunities will bring the net benefits for your company. If you are investing, you must be aware of the returns you’re earning on your investment. Perhaps a revamp of your website or your store will bring in more customers, or a new piece of equipment could provide you a whole new service line and income stream. The most important thing is to budget the return, the repayment plan and the capacity of your business. If you’re not sure whether the finance you take on will end up being a positive or bad debt for your company, talk to your accountant.