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

For many people the idea of debt is daunting to accept But the truth is that taking on the right type of debt could allow your company to grow and prosper. How do you figure out what kind of debt makes business sense? It’s all about assessing the long-term value the debt will bring to your business. What is key is comparing the benefits you’re hoping to accrue from the debt (such as being able to sell more) against the cost of borrowing (such as fees and interest) and ensuring the former is greater than the latter. So long as you’re using the loan to make purchases that can improve efficiency and productivity in your company, there’s usually nothing wrong with the use of debt. It can assist you in dealing with any unexpected short-term cash flow issues you could be facing. If you’ve run a stock business you’ll be aware of the cash flow problems that short-term companies often have to face. A partnership with a finance company can provide relief to stop any stock outs or get you access to the biggest discount of your product that is the fastest-selling.

What is good debt?

In essence, good debt allows an organization to leverage capital they wouldn’t otherwise be able to access so that they can increase the amount of money they earn. Good debt is one that can enable your business to move to the next step - it could be used to purchase an enormous piece of equipment for delivery vehicles, or even to help with marketing and advertising. As long as you’ve made some sort of return on the credit (bigger than the cost) the chances are it’s going to be considered a good loan. As an example, a skin abrasion and scar management clinic owner took out a modest business loan to acquire a new salon, renovate the salon and employ an experienced business coach. It was considered to be a great debt. The salon was quite old and deteriorated. I wanted to clean the place and create a a beautiful space where people wanted to come to, where it’s comfortable, homey and warm. It can also be employed to improve a company’s working capital, and to smooth out the cash flow challenges during challenging or slow periods for instance, like the summer holiday season for companies that provide services. For many, Christmas is among the most wonderful occasions of the year. As everyone other people are enjoying their holiday the holiday season can turn into the worst time for business in the whole year. When people pay you in late, sales could decline and suppliers would like to be paid.

What is bad debt?

Bad debt On the other hand typically will cost you more than the benefits you can get from it. It’s not likely bring in sales, or it’s unlikely to increase your bottom line, or unlikely to enhance the overall efficiency or value of your business. For instance, in certain circumstances, a company vehicle that is new could be a bad debt. If you borrow money to purchase the car will lead to you being able to provide more services to many more people at more locations or is a vehicle that you require in order to deliver an item, that’s an investment in value. However, if it’s just an automobile you’re purchasing in the interest of having a flash new company car and isn’t providing any direct benefit to your company, it’s a bad debt.

How can you tell if you are in the difference between good and bad debt

In order to determine whether the business financing you’re considering will be an excellent debt or a bad debt, it’s important to crunch the numbers. It is recommended to ask yourself these questions:

• How much money can I make with the money I’ve borrowed? What’s the chance?
• How much interest and costs will I be required to pay on the debt?
• Are I in a positive financial position in the long run?
• How do I have to wait to achieve that positive position?
• Can the money be used elsewhere for a better return within a shorter amount of time?
• Do I spend more than my budget?

It is also important to consider the possibilities that additional funding will provide, and whether these opportunities will bring positive outcomes for your company. When investing, you need be aware of the returns you’re receiving on your investment. Maybe a new website or your shop can attract more customers or a brand new piece or piece of equipment could provide you a whole new service line and revenue stream. The key is to plan the return, the repayment plan and the capacity of your business. If you’re unsure the likelihood of finance as a good or a bad debt to your company, speak to your accountant.