Most businesses carry some form of debt, be that in the form of loans, mortgages, or overdrafts.
Most businesses carry some form of debt, be that in the form of loans, mortgages, or overdrafts. Debt can be an excellent tool to help you grow your company, by allowing you to purchase new asset-producing machinery or expand your locations into new markets.
However, debt can also land your company in trouble. If you’re unable to service your debts, you can find yourself in trouble, or worse, risking insolvency. Not all debts are created equal, and understanding whether you’re taking on good or bad debt can help you to manage business risk.
In this article we look at good debt vs bad debt – which one does your business have?
Good debt
Debt owing on assets that earn income for you is considered good debt. Good debt might be in the form of a mortgage on property, or a loan enabling you to expand your business.
To define debt as “good”, it must:
- - Bring you positive returns. For example, a mortgage on a property with an interest rate of 6% must be returning a higher rate of profit.
- - Be something you require but cannot pay for in full. Good debt can be used to acquire assets for your business that you cannot purchase without wiping out your cash reserves. For example, equipment for your business that produces revenue.
- - Be on a payment schedule you can afford. Good debt fits within the everyday operating costs of your business.
Bad debt
This type of debt doesn’t produce any kind of asset. No bad debt will create an income greater than the interest it commands.
To define debt as “bad”, it:
- - Does not produce income: Instead of creating income for your business, bad debt only costs you money.
- - Doesn’t aid you in growing your business: Bad debt is spent on things you don’t need.
- - Is unaffordable: Your budget is stretched making payments on this debt, and it limits your ability to accumulate cash to acquire other assets.
Good debt vs bad debt: What’s the verdict?
Good debt, if managed well and payments are made on due dates, can be an excellent tool to grow your business. Bad debt can land you in trouble and heading toward insolvency.
Does your business carry a high level of debt? It might be time to undertake a debt audit. Look at each line of debt your business carries. Does it fit in the “good debt” category, or the “bad debt” category? You may be surprised to uncover just how much debt you’re actually carrying.
At McDonald Vague, we can help you figure out how to better manage your business debts. If you think your business may need help with managing its debts contact us now.