Almost everyone has heard the saying that any amount of debt is unacceptable. People view debt as one of the worst things they could be saddled with. You hear horror stories all the time; homeowners can’t make ends meet, the national deficit is simply growing larger, credit card spending is out of control, and university students are drowning in student loans and may never be able to recover financially.
When it comes to businesses, the facts are a little more straight forward. Borrowing can actually be a good thing. Many business owners do not have a background in finance, which is why the following four points are important to conceptualise. It is vital to understand that debt does not have to be a burden.
1. Giving Up Equity Costs More
This is probably the most important point to understand. If you are trying to secure money to run your business, giving up equity is going to cost you more than if you accepted some level of debt. When you give up equity, you give up some of your business permanently.
Consider the following information. When you begin your business, you have to pay employees, purchase inventory and get the equipment that you need to be successful. Investors will give you capital, but any money you make going forward is earmarked for them. If you take on debt, you do have to pay interest. However, there is a certain rate that you must pay and it doesn’t last forever. Once the business loan is repaid, you still have all your equity.
It is almost a certainty that you will not save money by giving up equity. That is why, in most cases, assuming debt is arguably the better choice.
2. Opportunity Cost May Be Higher Than Debt
Maybe you have just started your business and you want to make your first sale. However, it’s nearly impossible to do because you don’t have the money to purchase inventory. Suppose you can purchase the inventory for $5,000 and are able to turn around and sell it for $15,000. Does it make sense to borrow $5,000 at a cost of $1,000 to complete the order? If you factor in the APR, you would realise that you’d have a 20% APR over the course of the one year loan. If it were a two-week loan, the APR would be 520%.
While that sounds like a ridiculously high APR, it is still a better deal as long as nothing else is out there for you to take advantage of. This is because your return on investment is excellent. You’d make a huge profit, which makes it worth it. There’s absolutely no reason that you shouldn’t do it, even if math isn’t your strong suit.
Depending on the situation, debt can be your best option. You can make money and have opportunities that you didn’t have before. You just need to ask yourself if you are getting a high return on your investment and if that return is more than the debt. If the return is higher, it makes sense to strongly consider this option.
3. There Is Less Tax Burden When You Pay Interest
One reason that borrowing can be advantageous is that paying interest cuts down on your taxable profit. As a result, you don’t have to pay as much in taxes.
Capital costs less as a result, and it is important to consider that when thinking about what type of return you’ll get from assuming a debt. There have been companies that have been able to do very well for themselves by taking advantage of this tactic. It is something that small businesses should look at as well.
Borrowing, therefore, is starting to look better and better. Selling equity really shouldn’t be the first thing you turn to if you want to improve your business. You can lower your taxes through debt, which is a huge advantage.
4. Debt And Responsibility Go Hand In Hand
Small businesses usually don’t think about it from this point of view, but when you have debt, you think more about your finances and what the best decisions are for your company. As a result of this careful planning, you can do a lot of good for your business over time.
Obviously, this isn’t the only reason that you would assume debt. However, it is an advantage to factor in.
Why is that the case? When you have money, you aren’t as worried about money. When you don’t have money, you have to fight to stay afloat. When you have money, you may spend it on things that you don’t really need. When you don’t have money, you aren’t as frivolous and must really think about where your money is going.
That means that you will be more careful with your budget. As a result, you may earn more simply because you are not willing to indulge in things that you don’t really need.
You shouldn’t go into debt if you don’t have to. Still, if you are smart about the process, you don’t need to worry about debt. Instead, look at it as a way to help your business get bigger and better. Ultimately, it may cost you less than your other options as well. It’s not easy to run a business in today’s world. You have to do everything in your power to be successful. If you want your business to be around for a long time to come, making the right financial decisions is crucial.