Is There Such a Thing as Good Debt in Business?

One of the first things we learn about managing money is the importance of budgeting and making sure we’re not spending more than we have.

Tied into that lesson is the idea of “debt” as a kind of bad word. We tend to think of it as something to be avoided at all costs.

But not all debt is bad. As we learn more about how money works, we learn that going into debt is often necessary to make the big purchases we want and need to make in life, but can’t afford to pay off all at once, such as a car or a house.

There is “bad debt” and “good debt,” and while those terms tend to get a fair amount of attention in the world of personal finance, I want to explain what they can mean for your business.

How Can You Tell if Business Debt is “Good Debt?”

Each situation is unique, but, in general, taking out a loan to pay off something that won’t depreciate is considered good debt. For example, education and real estate are two things that almost always gain in value, rather than losing value, making those types of investments generally considered to be a type of good debt.

Bad debt could be considered taking out a loan to pay for assets that lose value over time, such as a vehicle (especially a new vehicle, which loses a lot of value as soon as it’s driven off the lot.)

Bad debt can also refer to the type of loan used to buy the asset. For example, a loan with high interest rates, excessive fees, or strict loan repayment terms is generally considered to be bad debt.

Finally, any debt you just don’t have the ability to pay back is bad debt.

Make the Most of Your Debt

As a business, your interest payments are tax deductible. That means that good debt can help your business be more profitable if you implement the right tax strategy.

Also remember that strategically using loans and paying them off on time is a great way to build your credit score. Your business can build a credit score, just like you can build your personal credit score. That will make taking out loans for your business easier in the future, and make it more likely you’ll be able to get favorable terms on those loans.

Tips for Getting Out of Bad Debt

If you find your business has bad debt, the first step is to analyze the company’s budget and financial statements. This will tell you what you’re currently spending to pay off that debt, and what you can afford to spend every month to pay off that debt.

The next step is to consolidate all bad loans into one loan. This helps lower your interest rates and is a great way to get a loan with more favorable terms.

It also just makes it easier to manage those loans if you only have to worry about making one loan payment a month instead of multiple loan payments to various creditors.

Just make sure the payment plan you end up with is one in which your business will plausibly be able to pay off the new debt.

Government-Sponsored Debt Programs

The U.S. government has several government loan programs businesses can take advantage of to borrow money for their company at competitive rates. The interest on those debts will be deducted from your corporate taxes. If your business files for bankruptcy, those loans might be reduced, or even forgiven altogether.

What Is a Healthy Amount of Debt for a Business?

There is no one number that defines a “healthy” amount of debt, because the number varies for each company. A good strategy is to make sure you are only taking on debt to pay for things that will help you achieve your business goals. And, of course, make sure you have enough room in your budget to be able to afford the payments on the loan.

It’s also a good idea to calculate the expected ROI of the loan. If you won’t make back enough on your investment to pay back the loan, it’s bad debt.

Need Help?

Figuring out if it makes sense to take out certain loans for your business sometimes requires diving deep into your finances and conducting some complex analysis. Whether you need help figuring out if it makes sense to take on certain debts for your business, or you’re trying to get your business out of bad debt, I can help. You can start the process of determining whether it makes sense for us to work together by filling out this form.