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

For many it can be a daunting task to contemplate But the truth is that taking on the right type of debt can help your business to grow and grow. So how do you work out which debt is good business sense? It’s all about looking at the long-term value the debt is likely to bring to your company. What is key is comparing the benefits you’re hoping to reap from the debt (such as being able to make more sales) versus the costs of this debt (such as fees and interest) as well as ensuring the former is greater than the latter. If you’re taking on the debt to finance purchases which will boost efficiency and productivity in your company, there’s usually nothing wrong with borrowing. It can assist you in dealing with any short-term cash flow issues you could be facing. If you’ve ever worked in the stock market and have experienced the short-term cash flow issues companies often have to face. Working with a financial institution can ease the burden of any stock sales or grant you the best deal of your fastest-selling product.

What is good debt?

In simple terms, good debt allows companies 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 debt that will aid your business in moving to the next step - it could be to buy an enormous piece of equipment such as delivery vehicles, or even debt to help with advertising and marketing. As long as you’ve got the potential to earn a profit from that debt (bigger than the expenses) then it’s likely to be considered a good loan. For example a skin wound and scar management clinic’s owner took out a small business loan to purchase an all-new salon, upgrade the facility and employ an experienced business coach. It was considered good debt. The premises were quite old and dilapidated. I needed to freshen them up and make a beautiful space where visitors wanted to be and feel homey and warm. The good debt is also utilized to boost a company’s working capital and smooth out cash flow issues during tough or quiet times such as the summer vacations for companies that provide services. For most people, Christmas is one of the best time during the entire year. As everyone other people are enjoying their holiday the holiday season can turn into the worst business period during the entire year. Customers pay late, sales may decline and suppliers would like to be paid.

What is bad credit?

Bad debt, on the other hand, is generally something that costs more than you gain from it. This means that it’s unlikely bring in sales, or it’s not going improve your bottom line or not likely to increase the overall value or productivity of your company. In certain conditions, a brand company vehicle that is new could be considered a bad debt. If you borrow money to purchase the vehicle will enable you to provide more services to greater numbers of people in more locations and it’s a vehicle that you require for the delivery of products, it’s an asset that adds value to your business. If it’s simply a vehicle that you’re buying just to get a brand new corporate car, and it’s not really contributing any tangible value for the company, that’s an unworthy credit.

How to distinguish the difference between good and bad debt

When you’re trying to figure out whether the business finance you’re considering will be a good debt or a bad debt, it’s vital that you analyze the numbers. He suggests that you ask yourself these questions:

• What is the maximum amount I can earn from the money I borrow? What’s the opportunity?
• What is the amount of interest and other costs will I have to pay on the amount of debt?
• Will I be in a better financial position over the long term?
• How do I have to wait to get to that situation?
• Can the money be used in other ways to earn a higher return within a shorter amount of time?
• Do I spend more than my budget?

Also, you should consider the opportunities that investing in additional funds can bring, and if they will provide an overall benefit to your business. If you are investing, you must to understand the return you’re receiving on your investment. Maybe upgrading your website or your shop can increase the number of customers you have or a new piece of equipment could give you a new service line and revenue stream. The main thing is you set a budget for the return, the repayment plan and the capacity of your business. If you’re still unsure of the likelihood of finance being a positive or a bad debt for your business, talk to your accountant.