by Roer Jimenez

Debt is a four-letter word we tend to easily avoid personally or for business. From a business perspective avoiding it may not always be the best way to achieve consistent cash flow.

So, are all debts equal?

Some debt can actually help grow your business. Rather than labelling all debt as “bad,” there are a few simple ways to recognise which debts are good, bad, or ugly.

Good Debt

Good debt is used to help build long-term wealth and makes financial sense.

A debt that will generate more money or value than the loan itself in the long term. In other words, this is debt with a positive return on investment.

Examples of good debt include a home loan (providing you didn’t pay too much for the property and can afford to pay off the loan), or a student loan, which allows you to gain qualifications that are an investment in your future career. Maybe a $15,000 loan for a business opportunity that increases sales by $30,000 is a worthwhile investment using good debt.

A canny way to use debt can be borrowing to invest in an asset, such as property or shares which can generate income and grow in value, while the interest charged on the debt is tax deductible.

Using long-term debt with a low interest rate and favourable terms to buy productive assets can add a little fertilizer to your business portfolio. However, even good debt generally has a downside – so don't add too much, and watch out for the weeds.

Bad Debt

The opposite of a good debt is a bad debt, where borrowed money is used for purchasing assets or items that immediately depreciate or lose value. It costs your business more than you get out of it.

An example of this would be borrowing on a high interest credit card to purchase a new sofa for the reception area of your business. Whilst it makes the surrounds nicer for your visitors, it won’t increase the production capacity or income of your business, and it immediately depreciates in value the minute it’s left the showroom floor.

If using the same $15,000 loan as above only increases sales by $5,000, then that would be a bad investment.

It’s important to note that we’re not referring to bad debt in the accounting sense, which is an accounts receivable that will not be collected for whatever reason. The bad debt we’re talking about is often taken on to cover sudden expenses or to purchase items that quickly lose their value. Good debt can also turn bad if the debtor has no strategy to pay it off.

Ugly Debt

Ugly debt is stressful. How can you tell if your debt has turned ugly? If it feels out of control, and you don’t know how or when you’ll be able to pay it off, it’s ugly debt. Maybe it’s just one overdue invoice in the hands of a debt collection agency. Maybe it’s a mess of overheads, staff wages, maxed credit cards and, to top it all off, the ATO is on your case about outstanding PAYG. Whatever the type and size of your debt. Ignoring any kind of bad debt won’t help, you should act immediately.

The Bottom Line

There is certainly an argument to be made that no debt is good debt. Unfortunately, few people can afford to pay cash for everything they purchase. With that in mind, a motto of "everything in moderation" is the right approach to take where debt is concerned. Remember, even "good" debt has a potential bad downside.

The path…. begin with the ugly, then the bad, and try to be good!!

If you are currently managing debt, start with the ugly. Address them head on and make a strategy to repay them. This might mean discussing repayment plans with your creditors, then confirming those discussions in writing.

Ensure your bad debts don’t turn into ugly debt. Be realistic; if you think you’ll find timely repayments challenging, be proactive and set up a payment plan ahead of time to avoid further penalties.

In future, before taking on any debt, ensure the opportunity will give your business a positive return on investment. If the opportunity makes sense, a business loan can be a great tool to help grow your business

How can we help?

Veritas Advisory is very experienced in assisting business owners and /or business lenders with dealing with good, bad and ugly debts, and from both sides of the ledger. Getting the right advice is the key and dealing with it as early as possible gives the best possible chance for a positive outcome.

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