I came across an interesting article today about business debt. Joseph Lizio, from Business Money Today, discusses how debt can be a great way to take advantage of a opportunities that will arise in growing a business IF it is managed properly!
He illustrates his point with the following example:
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.
Now, I thought that this was a good article because it points out that debt is not always bad. You see, there's a difference between GOOD debt and BAD debt. Bad debt is going into debt for anything that does not have the potential to make the money back for you. Examples: clothes, eating out, cars, televisions, etc. These items decrease in value once you buy them and will not help you pay back the money you are borrowing to get them.
Good debt, on the other hand, is debt that allows you to buy something that is creating value and cashflow so that you can earn more money than you were without the asset and will be able to pay back the loan from its proceeds. Examples: rental properties (some of them), businesses, equipment, etc.
You see, like the example of the businesses above - sometimes waiting until you have the money can hurt you in the long run IF what you are waiting to buy is something that has the potential to create value and income for you.
Now, I'm not saying to run out and rack up some debt - I'm just saying that some people are so closed-minded about going into debt that they are missing out on opportunities that could really help them get ahead in the long run. Don't be scared of having debt - just be SMART about it and make wise decisions.
-Troy Braithwaite, Utah's Authorized Duct Tape Marketing Coach
Quote of the Day: "Instead of wallowing in my misery, I just made some changes." - Stephanie Mills