Are you getting a return on your debt? We all know we want a return on our investments. But what about a return on our debt? 🧮
Whether you already have it or not, whether you like it or not, debt is highly likely to be a part of your life as a business owner at some point. 💲
So, the question is – is your debt… Good Debt or Bad Debt? 🤷♀️
Are you getting a return on your debt?
Let’s first talk about the debt at various stages of business.
These days there are plenty of businesses that can get started without the need for a huge monetary commitment.
Think side hustler turned fully fledged business person. Chances are your biggest financial strain will be plain old living expenses once you ditch the 9-5 as you transition from side-hustle to a full time founder.
But it depends what your startup is. Need stock? Need technology? Need professional advice? I can guarantee that whatever you thought it was going to cost you to start up your new business, you can add an extra 30%!
It always costs more than we expect.
It goes without saying that a cash buffer is essential. Without that buffer – and without a track record of profitability to back you up, the bank may not want to know you. This is where loans from friends, family or credit cards and home loan redraws come into play!
So, let’s talk good debt vs bad debt at this startup stage.
// Good Debt::
You’ve proven your offer. That is, you know there is a market for what you are selling. You already have some clients or sales. But your missing one vital piece of the puzzle to move forward with it.
If that vital piece is stopping you from moving your business forward AND you have forecasted the cashflow including your ability to repay the debt with interest in an acceptable period of time. Then this could be classified as good debt.
That ‘vital piece’ I refer to could be hiring a professional to do the things you know you can’t do, marketing, copywriting, an accountant to setup your structures, a lawyer to draw up documents or agreements. It could something bigger and more tangible such as an essential vehicle, warehouse or technology.
// Bad Debt::
Haven’t proven your offer?
Your sure there is a market out there but are they really going to pay for your thing?
Haven’t done a cashflow forecast which includes repayment of this debt with interest?
Your missing a vital piece of the puzzle to move forward with your business? That vital piece you are missing shouldn’t be simply ‘money’. Money to eat and generally get by day to day.
Money to live is something that you should have already organized, arranged, saved, or earnt while you go through this startup phase. To borrow just to get by while you startup… I’d call that bad debt or perhaps risky debt is a better way to put it.
The Business Buy-in
Buying an existing business can be expensive.
But depending on how the figures look – it can be an attractive way to fast track your business and be a viable alternative to the hustle and grind of the startup.
The price you pay to buy the business. This is typically the biggest debt business owners will find themselves in at this stage.
So, is the purchase price good debt or bad debt?
Did you overpay for your business? So many people buy with their heart not their head. If you buy with your heart the chances of overpaying are high. You need to have a valuation done by an independent professional. At least then if you do overpay, you know it! You are going into it with your eyes wide open.
// Good Debt::
Debt incurred purchasing the business is good debt provided you;
- Didn’t overpay
- You can walk into a business with proven solid profits OR
- Even better, when you can walk into a business and significantly improve profits. (ie, you know you can make some big changes fast and increase profits in the new business – kind of like buying the ugliest house on the best street and renovating!)
- You’ve done the cashflow forecasts and you know you can make the repayments including interest in an acceptable timeframe.
- >Your forecasts show that you have some room to move and you’ve been conservative in your forecasting.
- Your debt is allowing you to purchase an asset that can one day be sold – preferably for a profit!
// Bad Debt::
Debt incurred purchasing the business is bad debt when the opposite of the above is true!
It can also be bad debt if it structured the wrong way. For example, if the payback period is too short which can put unnecessary pressure on cashflow or it doesn’t allow you to pay it off quicker if surplus cash is available.
If all lights need to be green for this debt to be repaid, then you need to seriously rethink.
The Growth Business
Personally, I love this stage. There’s something exciting about watching a business grow**
**As long as that growth is controlled, profitable and sustainable**
This phase is possibly the most dangerous phase. Its easy to be blindsided if you’re not sure what to look out for.
Something to be on the lookout for at this stage is the banks eagerness to lend to you. Historically, banks have been eager to lend – it’s how they make a buck! If you are growing, showing a tidy profit and have a couple of years of good numbers, it can be too easy to get yourself into debt.
Never for a moment think that just because the bank will lend you the money means you can afford it or that it is a good business move. These days, this is possibly less of an issue post the banking Royal Commission in Australia.
// Good Debt or Bad Debt?
>Establishing or increasing an overdraft or short-term loan for cashflow – what is the purpose of this debt?
Is it to replace stock that’s turning over quickly? Is it to put together a marketing campaign? Is it to expand operations into a new geographical market? Upgrade facilities?
Whatever it is for the key is to ask yourself this question;
Can my profit and cashflow be improved by investing in this area?
You need to look at your debt as an investment in growth, an investment in your future. If you can’t, hand on heart, say that the debt you are about to take on will allow you to grow profitably – then you should reconsider.
If your increase in debt serves only to pay rising overheads while gross profit is stagnant or declining – then you should reconsider. You are moving into bad debt territory!
At the end of the day, provided you are forecasting your cashflow and you have an understanding of your finances you will be 3 steps ahead of everyone – including your competitors!
Getting stuck with bad debt is ugly and since you don’t ‘do’ ugly… keep this advice in mind when debt comes your way. And review your debt position now to see how your current position stacks up.