Borrowing beyond means can be harmful, especially high-interest debt, but there are instances when debt may be helpful. The key is to understand and respect the difference, know your debt-to-income threshold – amount of debt versus liquid assets – and use debt wisely. It’s true for your personal life, as well as your professional one.
It may seem counterintuitive, but “good” debt, like business financing, can actually enhance your financial position. Additionally, this type of loan often offers a low total cost of borrowing. Destructive debt has the opposite effect, eating away at your credit rating and putting you or your business in a vulnerable financial position. Bad debt is usually associated with buying things you simply don’t need or can’t afford.
Being overleveraged can derail a business from increasing net worth. That’s why it helps to understand debt-to-income ratio, the percentage of monthly gross income that goes toward paying obligations. Generally speaking, 36% or less is considered a healthy debt load for most.
Having ready access to liquidity through a loan also puts you in a position to act quickly should opportunity – or an emergency – arise. In the first case, cash can be invested, potentially earning a much higher return, and you’ll have liquidity for other goals. Perhaps you find a perfect new location or want to invest in equipment. Instead of liquidating assets, tap into a loan and make an all-cash bid for a property.
Borrowing, making payments on time and paying off a business loan helps establish an excellent credit rating – and can keep you from entangling your own finances by personally guaranteeing business loans. It can also result in lower future interest rates and fees for borrowing.
Borrowing in a smart and efficient way has a place in just about any business plan. The key is to consider each facet of debt strategically. As you make your decisions, think about:
Debt can be a powerful tool that enables you to use capital in other ways, thus helping you achieve your goals faster than saving might. Remember, too, that taking on some debt is a financial decision, one made easier with a little help from knowledgeable professionals – like your financial advisor.