Understanding good debt
The old adage of ‘you need money to make money’ rings particularly true when securing funds to start or grow your own business. Expanding a business often involves going into debt, but it’s important to acknowledge there are two types of debt: good and bad.
Here are the differences, and why good debt can actually help when growing your business.
Good debt vs bad debt
Debt, simply defined, is a liability or obligation owed to another person or party. For small business owners, debt is essentially funds borrowed for your business. What many people fail to realise however is that debt can be both ‘good’ and ‘bad’. How it’s classified depends largely on the circumstances in which funds are borrowed, how they are put to use and the financial position of the borrower.
What’s good debt?
Good debt is often necessary for the establishment or future growth of a business. Debt is considered good when invested in purchases that benefit the business. These investments might help by generating income, reducing overheads or growing the business’s overall asset value. Good debt can be tax deductible and should be financially sustainable – but remember your business cash flow must be able to make the loan repayments.
Good debt enables businesses to become bigger, stronger and more efficient. For example, taking out a loan to purchase equipment for your construction company, which will expand your business offering and streamline productivity, would be considered good debt.
What’s bad debt?
Bad debt, on the other hand, is the use of funds for reasons that don’t bring any benefit or wealth to the business. These include unnecessary purchases or items that will quickly depreciate. Upgrading a car, for example, won’t generate extra income for the business, and often the business is unable to generate the growth needed to cover the cost of repaying that debt. These purchases are generally not tax deductible either.
The conditions of a loan and a business’s inability to meet them can also make a debt bad, such as when a loan has a high interest rate and the business struggles to meet the minimum repayments. Unsustainable debt is bad debt and detrimental to the business’s financial health. Note that borrowing money to pay credit card debt is almost always bad debt, as it doesn’t contribute to the growth of the business in any way.
Women and good debt
Women make up over a third of all Australian business operators (34%), and this figure continues to grow. For women looking to expand their own venture, good debt in the form of a loan may be the way to do it.
Suzanne Flanders used a small business loan to grow her Perth-based day spa, Simply Beautiful Hair and Beauty, in August 2016. At the time, Suzanne lacked the cash flow to invest in much-needed upgrades. After evaluating her external finance options, and learning about an offer from Prospa-powered Reckon Loans, she shunned the big banks and applied for a small business loan.
“It was hassle free,” Suzanne says. “They only considered my main business account, not my personal financial situation, and I did not have to provide any other paperwork.”
The funds were used to expand the rooms in the salon, invest in marketing and bring in a new brand, Skinstitute. An example of good debt, Suzanne’s decision has “already been very successful” and has improved her business offering significantly.
Similarly, when Nyoli Scobie of Truly Tea missed out on a huge opportunity because the big banks wouldn’t fund her, she turned to Prospa for a small business loan that allowed her to explore new business opportunities.
“I was asked to supply airlines and tender for the Commonwealth Games,” Nyoli says. “But I couldn’t do any of it without funding, because I’d have to supply product up front and it would’ve sent me broke.”
So when Nyoli was asked to supply tea to the entire Opera House, she needed an alternative. “I instantly said yes, then got off the phone and thought, now what? That’s when a contact of mine told me about Prospa and I gave them a call.”
The quick approval time meant Nyoli had the funds she needed within 24 hours. This kind of good debt has changed her business, enabling her to win an export contract to supply tea to Korea, with other international opportunities on the radar.
“Now I don’t need to miss opportunities any more,” Nyoli says. “How amazing is that?”
If you’re looking to grow with a small business loan, talk to Prospa on 1300 882 867 or apply online and find out how we can help make it happen.