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Is There Really Good Debt and Bad Debt?

By Mobilization Funding – 

MoneyYou know the old saying, “You have to spend money to make money.” Growth takes capital, and for a lot of small businesses, that extra cash is going to come in some form of debt.

If the very thought of taking out a loan to finance growth makes you shudder, you’re not alone. A lot of small business owners avoid debt like the plague, and when they do seek financing, it is usually in dire circumstances.

Which is actually part of the problem. If your only experience with debt is emergencies, chances are your perspective on debt is negative.

Most business owners only take on debt in worst-case scenarios

Meet Kelly, owner of Kelly’s Creations.

Kelly has owned and operated a small salad dressing and condiments company for 10 years. Kelly is very proud of her fiscal responsibility. In her early twenties she had a small mountain of credit card debt. It took her years of pinching pennies and sacrificing new things — not to mention sleepless nights and constant stress — before she could finally pay it all off.

Now, she pays for EVERYTHING in cash, both in business and in her personal life.

One day a customer comes to Kelly with an order too big to fill with her traditional materials budget. It’s a huge opportunity for her company, but she’ll need a funding source. Kelly thinks she’s a shoo-in for a small business loan. She’s never missed a payment to any of her vendors and she has a small stash of reserve cash in her bank account.

But what Kelly doesn’t have is credit history. Since she’s never borrowed before, there is no way for the bank to ensure she’ll be responsible with the debt. She is denied the loan.

Kelly is in a pickle.

Debt is not inherently bad

As Kelly learned, sometimes debt is necessary to reach your goals. We know this is true on some level because most of us take out a mortgage when we buy a home, or a loan to buy a new car. We accept these forms of debt as necessities. But when it comes to business, many small business owners see all debt as bad debt.

Not all debt is created equally. Good debt helps you grow. Bad debt weighs you down. How can you tell the difference?

Glad you asked.

There are commonly held beliefs on what constitutes “good debt” versus “bad debt.” Common examples of good debt are:

• Mortgage
• Lines of credit
• Small business loans
• Automobile loans
• Student loans

These are loans that either pay for an essential in your life, like a house or vehicle, or represent an investment in yourself or an asset that will pay you a return.

Bad debt, on the other hand, has no chance of generating long-term value or income and/or pays for something that quickly loses its initial value. Bad debt examples typically include:

• Credit cards
• Payday loans
• Merchant cash advances
• Automobile loans

Did you notice something odd? Automobile loans is on both lists. That is an important point — automobile loans allow you to purchase an essential life item, but the loan itself does not typically generate income and the item in question quickly loses its value.

It’s not the debt that is bad or good. It’s how you use it.

Good debt is all in how you use it

It may be convenient to classify one type of debt as “good” and another as “bad,” but these labels do business owners a disservice. They strip you of the power to decide how debt will impact your business.

For example, credit cards are commonly thought of as bad debt. But, if you are a small business using a credit card to purchase supplies and you pay the card off every month, this is actually good debt! You are using the money to leverage your buying power to grow your business and you are building a solid credit history.

Even merchant cash advances, which we talk about at length, are not inherently bad debt. Are they risky? You bet. Do we caution business owners in industries like manufacturing and construction away from them? All day every day. But, plenty of business owners use MCAs effectively. They understand the payment structure and know their cash flow can support it. See how it gets complicated? The real question is not whether a source of funds is good or bad, but whether you will use the money in a way that allows the investment to pay for itself through business growth and revenue generation. Click To Tweet

Borrowing to capitalize on a great opportunity, like Kelly and her big order, can be the difference between reaching your growth goals or… not.

So now you know that debt is neutral until you use it. The next question is, how much debt should your company have?

How much debt is too much debt?

Now we come to the crux of the matter: balancing opportunity with debt. How much debt is too much debt? There is no hard and fast answer; it depends on your business’ growth plans, the type of debt and cash flow. You can and should keep an eye on your company’s overall debt, especially as it compares to your total income.

This is something your CPA should be reporting on each month — you do have a CPA, right?

The fate of your debt lies in your hands

Are you worried about Kelly? Don’t be. She found the funding she needs, and has since opened up lines of credit with a few of her suppliers and hired a CPA to help her develop financial strategies that will grow her business. She still pays for most items in cash — old habits die hard.

Debt is not a force of evil. It’s a tool that, when used correctly, can open doors to new opportunities for your business, help you achieve your goals, and give you the foundation you need to GROW.

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About About the Author: Mobilization Funding provides cash-flow relief to business owners through contract-based loans and purchase order financing for commercial construction subcontractors, manufacturers, and fabricators. Mobilization Funding provides the working capital you need when you need it MOST — at the beginning of a project. They work with you to build a repayment schedule, so you pay them when you get paid. They don’t look for clients, they look for partners in success. Learn more about Mobilization Funding at mobilizationfunding.com.

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