To paraphrase Shakespeare: “To borrow or not to borrow? That is the question.”
Many people believe that debt of any kind is worse than no debt, but there may be very good reasons to incur short-term debt for long-term gain. There are situations when taking on debt can be a positive and strategic move for your business. In other words, the value of debt is determined by the return provided by that debt.
Without a doubt, a well-run business needs to control expenses in order to maximize profits. Interest expense is similar to every other expense in many ways. One major difference, however, is that while most expenses pay for regular overhead that is consumed in the normal course of business (salaries, rent, utilities, supplies, etc.), interest expense can represent an investment in the future.
- Debt can be better than losing an opportunity. When your company has the opportunity to take on a large or unusual job from a new or existing client, debt may make sense. If there are upfront costs, such as hiring labor, purchasing inventory, or upgrading equipment in order to complete and deliver on the job, debt can help make that happen. Loan proceeds are used to fund the upfront costs. The debt is then repaid when the payment is received. Do the math, and make sure there is true profit at the end of the process. Don’t forget to include overhead beyond the upfront costs when calculating the profit.
- Debt is often more desirable than giving up equity. While offering equity may seem like a simple solution to the growing needs of a small business, it means giving up a percentage of your business and, therefore, future profits that are a result of your hard work…forever. Debt can be repaid quickly when compared to equity, which can be permanent.
- Debt can add stability to seasonal cash flow. A lot of successful companies are seasonal in their business and, as a result, seasonal in their cash flow. Debt can help even out the cash flow cycle, providing cash during the lean months while being repaid during the flush months.
- Debt forces discipline and frugality. Having to make regular loan payments on debt helps keep you focused on cash flow. Without having those payments, an influx of cash might tempt a business to spend money on things beyond necessities. Lean businesses tend to keep on top of expenditures.
- Debt may reduce your taxable income. While I’ve never understood the idea of paying the bank $1.00 in interest to save $.25 in taxes, interest is generally tax-deductible. So while I don’t think tax savings is a reason to take on debt, I do believe it is a nice benefit if a loan is already under consideration. The tax deduction is a potential benefit for all of the previously mentioned scenarios beyond the benefits mentioned in each situation.
Remember, when it comes to taking on debt, all loans are not equal. It’s important that you find a lender who understands your business, understands the reasons for the loan, is willing to lend you money at a reasonable rate, and can provide you fast, convenient, and personal service.
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