Most businesses need some form of credit or borrowing at some point in their lifetime. Whether it’s a start-up loan to get things moving or simply an overdraft facility to help with cash flow, having the right access to lending can help a business survive or even thrive. Basically there is no shame whatsoever in a business being in debt – that is as long as it is the right kind of debt…
Indeed, in this world there are two distinct kinds of debt – good debt (or at the very least, acceptable debt!), and bad debt. An example of a good or acceptable debt is the metaphorical one you owe to your parents for giving you life, whereas a bad debt is the kind you owe to the Mafia after some ill advised heavy betting on the Super Bowl.
In this post we are going to look at some examples of good (ie, acceptable!) business debt and bad business debt with an emphasis on how to avoid the latter. So, good vs bad business debt round 1!
Is There Really Such A Thing as a Good Debt?
Ok, so in an ideal world none of us would ever want to be in debt to anybody. After all, earning money simply to hand it over to pay for pleasures we’ve already enjoyed kind of sucks. But, in the world of business finance things are a lot more complicated.
Firstly a good debt is one that will benefit your business in the future in some way so perhaps try to look at it as an investment but one funded by a creditor rather on your behalf!
Next, a good debt is one which your business can comfortably afford to service each month, even when cash flow is interrupted or when there are sudden, unexpected extra outgoings.
An example of a good debt is a Start Up loan. While borrowing money to launch a business is risky, it is ultimately a positive step. If the business proves successful (and remember, the bank believed it would be when lending the money) then the loan will be repaid within a few years and you will have a business that earns you money.
Another example of a good debt is a mortgage to buy business property. If your business is renting its premises, then that is unfortunately money down the drain. On the other hand, channelling what your business would pay in rent towards a commercial mortgage does not impact outgoings, and means that your business will have an asset at the end of the term.
And What Is a Bad Debt?
In contrast, a bad business debt is simply one that will just drain resources and offer no long term value.
A great example is over reliance on the business overdraft. Perpetually operating from inside an overdraft means incurring fees and interest charges month after month simply for conducting ‘business as usual’.
Another example is a business car loan. Maybe you really do need a car in order to run your business, but using a loan to pay for it means paying above the market price for an asset that will decrease in value the second you drive it away from the showroom.
Another form of bad debt is any debt that stretches your business too much and leaves you struggling to pay it each month. From this perspective, even a good debt can become a bad one if you borrow too much and end up struggling to repay it. If a business is directing all of its cash flow towards servicing debts that leaves them unable to expand or explore new opportunities.
It may also mean having to use credit facilities such as credit cards and overdrafts to pay loans and mortgages – in short, getting into debt to pay debt.
Next, Meet Ambiguous Debt!
Some business debts are not necessarily good or bad but can either, both or neither depending on the exact context.
For example, a debt consolidation loan is on the one hand a drain on resources that offers no long term value, but on the other, it does help to minimise and manage other debts. Paying a single, low interest loan can sometimes be a lot smarter than paying 2 or 3 credit cards.
Next, a loan to buy business tools or equipment also falls into this category. Basically the equipment will help the business to grow, but will also lose value immediately.
Final Thoughts on Good vs Bad Business Debt
In summary, business borrowing is a reality of operating any kind of enterprise. Owning money can make even experienced business owners nervous but as long as the debt is manageable, and will ultimately benefit the business it should be viewed as a good business debt.