Do you hold the belief that all debt is bad for your business? It’s true that unmanaged debt can quickly get out of control, but debt chosen carefully for the right reasons can allow your business to take advantage of opportunities that you’d otherwise have to pass up.
I want to dispel some of the myths about debt by demonstrating that debt can be a great way to take advantage of opportunities that will arise in growing your business – as long as it is managed properly!
Two similar businesses (Business ABC and Business XYZ). Each earns $10,000 per month in profits. Both have an opportunity to purchase a second piece of equipment for $120,000 that would double the business’s profits.
Business ABC – saves its monthly profits and plans to purchase the equipment in a year from now – assuming that the opportunity has not disappeared.
Business XYZ – leverages its current monthly profits, takes a loan and buys the equipment right now. The business uses its current earnings to qualify for the loan and plans to use the additional profits from the new equipment to repay the loan – called leverage.
(Note: does not have to be just for equipment – could be working capital to bid and win a large customer, to change location that has better traffic, to build inventory, or even to complete a big order that was just received).
One year later:
Business ABC – now has $120,000 in the bank ($10,000 per month for 12 months) and wants to purchase the equipment. However, the equipment, due to inflation, now costs $130,000. So, Business ABC will have to wait and save for an additional month before it can purchase the equipment and double its monthly profits.
Business XYZ – has been earning $20,000 per month with the new equipment – less the cost of the loan (say $4,000 per month for an 8%, 36 month facility – life of the equipment). It now has $192,000 in the bank.
So, which business is better off?
Business XYZ – due to financing the equipment – has earned $6,000 per month more than Business ABC over the last 12 months (or $72,000 in total). Not only does this business use the equipment to pay for itself, it has generated additional profits to find and fund new opportunities.
Every successful company in this country and around the world has used leverage to grow their business to the successful companies they have become.
Additionally, debt, if the funds are used to pay for themselves, is a great way to keep your current cash in the business (working capital) while growing your operations – financing equipment in this case.
The upshot is that you can really improve your business’s bottom line through the proper use of debt – e.g. using debt to either purchase assets or invest in your business, which in turn returns enough profits to pay back the loan – all the while keeping the cash you do have available for new opportunities that may come along.
Debt should not be feared but seen as a tool that can help grow your business.
Copyright 2009 – BusinessMoneyToday.com