Advivo explains whether debt can be beneficial for your business, and how to manage different kinds of debt.
Debt is a topic that is at the forefront of every owner or director looking for small business advice, especially when starting out. Despite its scary reputation, there are certain types of debt that can be considered ‘good’, and of course, others that can be considered ‘bad’ – although they are not always easy to identify.
What is ‘good’ debt?
Although debt is often considered to be a negative aspect of running a business, there are times when debt can be advantageous in the long run – with correct planning. As Jon Hanson, author of Good Debt, Bad Debt says: “debt that enables you to safely set up a cash flow or return in excess of its costs is a good debt”. For example, it is good small business advice to obtain debt that is likely to provide a return on investment. This could be in the form of taking out a loan to get your business off the ground, and then returning this investment with profit, income producing assets the key is financial modelling whether after servicing the debt the investment will deliver a positive return.
Ideally, any investment is more effectively funded from profits. However, debt is the next cheapest form of funding and equity raising the most expensive.
What is ‘bad’ debt?
In simplest terms, bad debt is any debt you’re unable to repay or debt that involves diminishing returns. Obvious examples of the latter in everyday life include assets such as cars and consumables that depreciate in monetary value after they have been purchased. However, in terms of business debt, this can be a bit more difficult to identify as bad debt can result from the mismanagement of good debt. That is, an investment into a potentially beneficial venture cannot be repaid as it has not produced a profit for various reasons.
How do I know whether I have good debt or bad debt?
Owners looking for small business advice can often find it tricky to decide whether they are investing their time and money into a debt that is good or bad, and whether they are at risk of turning their good debt into bad debt.
