Do you wonder how much debt your business should have? You need to make sure that you’re able to support your core business functions but don’t take on so much debt that it’s impossible to pay back. In this blog, we’ll break down everything you need to know about business debt management.
Debt: A Tool, Not a Crutch
Let’s begin by clearing up some misconceptions, starting with:
“All debt is bad debt.”
While debt can be an intimidating tool to rely on, most small businesses will need to accept some to maximize organizational growth. Proper debt utilization builds your organization’s credit score, creates growth, and helps you pursue revenue-boosting opportunities. The key is knowing which kinds of business debt are worth pursuing.
On the flip side, business owners overly eager to take on debt believe that:
“I can solve my debt issues with more debt.”
This is an extremely dangerous attitude to have and leads to business failure. Debt is a tool, but it should never be used as a crutch. Before taking any on, business owners should always ask themselves:
“Will this debt increase my company’s future value?”
If the answer is yes, it may be worth pursuing that business loan or other form of debt. If the answer is no, you should avoid it.
The Difference Between Good Debt and Bad Debt
You can tell the difference with these three questions:
- Will this increase my business’s future value?
- Can this debt interfere with my other operations?
- Am I taking this debt out of necessity or because it’s a wise choice?
Good debt is an investment in your organization’s future. Bad debt is a flimsy bandage over larger, underlying problems.
Types of Good Debt
Even though the following types of debt are listed as examples of good debt, every debt can be bad depending on the circumstance. Generally speaking, these debts will increase your business’s future value and help your organization grow.
One of the best borrowing options for small businesses in the U.S., SBA loans are partially guaranteed by the U.S. Small Business Administration, making them low-risk and increasing approval rates. Best of all, they have generous repayment terms, giving borrowers a long time to repay. There are many programs depending on why you need funding, your credit score, and how much you need.
Real Estate Financing
Real estate financing is a crucial option for businesses that need commercial space but don’t have the liquidity to secure it. Real estate loans offer low-interest rates and flexible terms based on the borrower’s situation.
Equipment or Operational Financing
Many small business owners find themselves in situations where they need to expand operations fast but don’t have the capital to secure the necessary equipment. If you’re in this circumstance, equipment or operational financing is a great option.
In these types of loans, the financed asset itself is used as a form of collateral, resulting in a great low-interest, flexible debt. With business models and financing being highly volatile in the wake of the pandemic, the importance of this flexibility couldn’t be overstated.
Interested in Learning More About How the Pandemic Shaped Businesses?
One of our recent blogs breaks down how the pandemic has shaped the professional world and what businesses can do to recover. Check it out to learn more.
Types of Bad Debt
While any debt can be useful in the right context, these financing options usually do more damage than good:
These are a tempting option for those who need cash but have no liquidity, but most are offered by predatory lenders who’ll charge exorbitant interest rates. These loan sharks target business owners with no other options by enticing them with promises of fast financing and upfront cash. While their offers seem great on the surface, carefully examine their repayment terms before signing an agreement.
Debt to Cover Other Debt
While this isn’t a specific type of loan, this refers to any business debt taken on with the purpose of paying more off. This strategy never works and leads business owners through a vicious cycle of rising interest rates and progressively aggressive lenders.
Things to Know Before Taking on Business Debt
Now that you understand the difference between good debt and bad debt, let’s review some things that every business owner should know before taking on any business debt.
Debt Can’t Account for Poor Business Strategy
Before you ever take on a loan, you should ask yourself why you’re in a situation where you don’t have the capital to pay for an investment yourself. What is it about your current business model that isn’t working? Debt isn’t a solution to your business’s deep-rooted business—don’t treat it as such.
Properly Used Debt Increases Your Net Worth
When used correctly, debt will increase your company’s net revenue and value by allowing you to pursue otherwise inaccessible revenue-generating activities. Ideally, it should pay for itself and then some. The key to successfully leveraging debt? Research! Research every opportunity to see if it’ll be successful. Run financial projections, survey your market, and consult with experts.
Study Your Interest Rates!
A difference of a few percentage points could mean tens of thousands of dollars down the line. Make sure that you understand exactly how the interest rate you’re being offered impacts your business’s finances. Never take a loan with an interest rate you think you’ll struggle to repay. This will damage your credit score and make securing competitive loans in the future more difficult.
Upgrade Your Accounts Receivable
One of the best ways to minimize your reliance on debt is by upgrading your accounts receivable practices. Do you have a lot of outstanding accounts that you’re struggling to collect? If so, turn to Rapid Collections. Whether you need help with single business debt collection or need assistance with hundreds of outstanding accounts, we’re the ultimate solution to outstanding accounts. Contact us today to transform your AR.