Small business ownership is not a walk in the park. In fact, the average small business has around $195,000 in debt. Some of it’s good, and some of it can sink their business.
If you own a business, you might want to know if an installment loan for your business development is a good or bad debt. So, here we are to tell you about the difference between good debt and bad debt, and how much should I be taking out? Well, let’s talk about that.
Define Good Debt
The best way to focus on good debt is to know exactly what it is. Some debt is perfectly beneficial to a business, especially one that’s starting up or trying to climb a ladder. Capital is almost always the only way to grow.
If you take out a business loan at under 5% interest rate and you spend that money on items that will help you with scale, efficiency expanding your customer base, or even saving you money, that’s perfectly good debt. There’s not a sharp limit to how much of that kind of debt is bad, as long as the rewards of the purchases are reasonably certain.
Buying an office location instead of renting will save you money in the long run, so a mortgage would be an example of good debt. Buying bigger trucks for distribution is great! Buying anything that will increase in value over time is another example of good debt!
Define Bad Debt
The same logic applies to bad debt. You need to know what you’re avoiding. Essentially, bad debts are high-interest debts in general, to an extent, and unnecessary debts.
For startups and small businesses, owners need to drop a lot of money a lot more often than they’d like to. It’s okay to throw some of those expenses on a credit card to build business credit, but it becomes bad debt when you build more credit card debt than you can handle.
Any debt taken out for something unnecessary for the growth of your business is also a mistake. If you’re taking out any debt, it should be an investment, especially early on in your business.
A good debt-to-income ratio (DTI) is below 50% and ideally under 36%, so try to keep it there to make sure you don’t get turned aside for necessary loans in the future.
Write A Plan
The best thing you can do once you know what kinds of debts are worthwhile and which are not is to write a plan of how you’re going to manage your debt moving forward. If you have some bad debt, cut your losses and pay it off as quickly as possible. The only thing you can do about it is to avoid it in the future.
Define what good debt means to your company. Think in terms of investments. You need the basic essentials for your business to function, of course, but there are likely purchases you could make to make certain processes cheaper or more efficient over the long run. Then, write out a list of traps or bad habits that you’re worried about overspending on.
There are plenty of small moves you can make to help your business. Once you have types of debt defined and know what you’re buying, see if you can write out a timeline for your future purchases! Pay attention to how much you borrow, try to pay off your debt as quickly as possible, and keep your DTI nice and low!
Now that you know about good debt and bad debt, ask yourself before every purchase (no matter how small) how it will help your business. Stay up to date with our latest business news, keep your business running, and contact us for any help you need!