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Should A Company Go Into Debt?

When you first start your company, it’s easy to fall into the thought process that you’ll have clients throwing their money at you and that maintaining a positive cash flow will never be an issue.

However, keep in mind that your company is new. You'll need to start creating your products, which may require new equipment. Once you have your products, you'll need to advertise them so your clients know to buy from you.

At this point, companies need to decide how to raise funds, either through investment or by approaching lenders.

Investment can be beneficial in some cases; however, it means giving up a portion of the company's equity and may come with strings attached. Whereas approaching lenders and taking on debt means you keep the full equity in the company.

Before deciding to take on debt, you first need to understand the difference between good and bad debt.

Is there such a thing as good debt?

In short, yes, there is such a thing as good debt.

In the business world, taking on a healthy level of debt can help a company to grow and expand into new markets. Therefore, the debt is taken on with a clear purpose, such as buying new equipment for an expanding team.

Also, consideration needs to be given to who is lending the money. If it’s a low-interest loan from a reputable lender, it could be considered to be good debt.

Remember, to be considered good debt, the debt must:

  • Be for a specific purpose
  • Be low-interest
  • Be manageable while maintaining a positive cash flow

What makes debt bad?

The description of good debt makes it seem as though all debt is good in a business; however, that’s not the case.

Bad debt tends to creep up on a business without warning. Imagine a key piece of equipment breaking down at your company, but you don’t have the cash on hand to replace it. You have two options here: either stop using the equipment and absorb the financial hit from not producing your products, or take on short-term debt to cover the repair costs.

Unfortunately, short-term debt often has high-interest rates associated with it, meaning your cash flow can take a hit while you repay it. Also, as it’s an unexpected debt, the company won’t have factored the repayments into its cash flow forecasts, which could have an unexpected long-term impact.

Bad debt in accounting

If you carry out the accounting in your company, you might have come across the term “bad debt”, which doesn’t fit with this explanation.

In this scenario, bad debt is money owed to your business that you have no way to recover. For example, one of your clients may have gone out of business, so there is no way to recover the funds.

This type of bad debt is typically written off by the affected company, which also negatively affects their cash flow.

What should I do?

There’s no wrong or right answer to this question. Sometimes a company needs to take on bad debt to survive a crisis.

Other times, a company needs to take on good debt to realise its full potential.

If your company is in a position where it can take on debt without it negatively affecting your cash flow, then you’re in a good position to take on necessary debt, which can help you to grow. However, you need to carefully consider whether this is the best option for your company in the long-run.

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