Debt is a word that can strike fear into any small business owner’s heart. While in many cases debt can cause problems for a business, certain types of debt can also benefit a business in the long term. We are here to highlight that there are three different categories of debt for a small business: good debt, bad debt, and avoidable debt. When you are considering taking on debt for your business, SureBooks accounting services will offer you expert advice to help you select beneficial debt for your business.
Good Business Debt:
It may sound like an oxymoron, but there is good debt for small businesses. Good debt is debt that will ultimately benefit your business in the long term by enabling you to increase your income and profits. Good debt also generally has a low-interest rate and suitable repayment terms that suit the current and projected financial position of your business.
Debt is often unavoidable for small business owners, especially when you are starting a business. It is imperative for the future of your business that you select the type of debt that will have positive results for your business. We have highlighted a few of the reasons that debt that can be good for your business.
1) Purchase Essential Business Equipment:
Whether your business provides a service or products, there will be essential business equipment that you will need. From a laptop to machinery, initially funding these essential items can be costly. Taking a small loan to get your small business equipment is good debt as it allows you to begin generating an income for your business, which then allows your business to grow and become successful.
2) Build Credit Score:
While purchasing items by using a loan or on credit is debt, a good business credit score is essential to demonstrating your financial reliability to future financers. For a small business, getting a credit score can be done through taking out small business loans or having a business credit card. By paying off your debt within your repayment terms, you will begin developing a good credit score for your business. Building a good credit score will enable you to take out larger loans in the future should your business need to expand further or take on a business opportunity.
3) Expand Your Business:
Many small businesses experience rapid growth but are financially unable to afford the expenses needed to expand their business to meet their demand. This is where debt can be a positive thing for a small business. Taking a loan to purchase additional workspace, hire more employees, or increase your production rate will ultimately allow you to earn more money and therefore positively impact the future of your business.
4) Improvements to Meet Safety Regulations:
The Occupational Health and Safety Act 85 of 1993 (OHS Act) has created numerous regulations and rules that all workplaces are complied to follow regarding reducing safety hazards for employees. Your workplace may require additional safety measures to be put in place to be compliant with the OHS Act, and this will be an additional expense to your business. Taking out debt to make improvements to meet safety regulations will not benefit your business by earning you more money, but it will save your business money. You will avoid penalties, fines, or stopped operations if your workplace is found to be non-compliant.
5) Supplier Credit:
Supplier credit is a common debt for many small businesses. Supplier credit refers to purchasing products or supplies from your supplier on credit and then paying your supplier back within your agreed repayment schedule. You will be in debt to your supplier, but this debt enables you to create your product that will then earn you an income without the initial expenses. Maintaining a good relationship with your supplier by paying them back on time is essential to keeping this debt categorised as good debt.
Bad Business Debt:
In essence, bad debt is the debt that will not assist your business in generating any income, will impact the future financial situation of your business, or is associated with depreciating assets. Bad debt is usually demonstrated by high-interest rates, strict repayment terms, and multiple penalties. This is the debt you should be concerned about as a small business owner.
Bad debt is the debt that keeps small business owners awake at night as they struggle with the challenges that this debt can create for their business. We are here to assist you in spotting the bad business debt before you take this debt on (and lose sleep over it). We have listed three examples of bad business debt that can have dire consequences for your small business.
1) Debt Caused by Poor Financial Management:
Poor financial management of your small business can quickly lead to bad debt. Not managing your accounts efficiently can result in various penalties that your small business will have to pay. Penalties can be incurred by missing loan repayments, your tax payments, or payments to your suppliers. You may need to take out additional debt to pay off your penalties, which creates a cycle of bad debt for your small business.
This debt can be easily avoided with increased financial management efficiency. It can be difficult for small business owners to run the daily business operations and keep on top of the business financial management. Accounting services off effective financial management that will ensure that you avoid having to take on extra debt to pay for penalties incurred from missed payments.
2) Car Loan:
A car loan is a difficult debt to categorise. Taking a loan out for a car in the name of your small business is generally considered bad debt as a car is a depreciating asset. On the other hand, you need a vehicle to get you to your business every day, attend meetings with potential clients, and meet with suppliers. A car loan for a truck or bakkie may be essential if your personal car cannot transport your products around.
A car loan becomes bad debt when you are impractical about the car you choose and the related costs. Generally, you do not need the latest car model bought brand new from a dealership. There are multiple second-hand dealerships and private seller options that can provide you with a more affordable range of vehicles. Ultimately, you must just consider the impact of this car loan against your expected business income and make sure you are not turning your business vehicle into bad debt.
3) Loans to Clients or Employees:
Loaning finances to clients or employees should be avoided as it can quickly generate debt for your business. If your clients or employees are unable to pay you back due to unforeseen circumstances, you will be forced to write off the loan and absorb the expense. If you were depending on that money for paying off your business debts, it can then increase the negative circumstances for your small business.
Avoidable Business Debt:
Avoidable business debt is unnecessary debt that has been accrued by a small business that could have been avoided by making better financial decisions. Avoidable debt is heavily tied to bad debt, as by taking on this unnecessary debt you are placing your small business in a high-risk position. We have highlighted three types of debt that your small business should avoid to reduce the risk of negative consequences for your business.
Using Debt to Pay For Unexpected Expenses: Unexpected expenses can take various forms for a business, such as your work vehicle being stolen or your business equipment breaking down. Acquiring additional debt through financing to pay for your unexpected expenses highlights an issue with your financial management. Every small business should have an emergency fund for unexpected expenses. By budgeting correctly and setting aside a small portion of your income each month into your emergency fund, you can prevent your small business from taking on this unnecessary debt.
Excessive Credit Card Use: While having a business credit card to generate a good credit score is a good type of debt, it can also quickly lead to debt that should be avoided. Relying heavily on your business credit card to cover expenses will end up costing your business more in the long run due to the higher interest rate on credit cards. Purchasing items on credit that you should be using your budgeted income to purchase demonstrates problematic financial management which needs to be rectified to avoid this unnecessary debt.
Accruing Debt for Unnecessary Expenses: Small business owners often make the mistake of accruing unnecessary business expenses. Unnecessary business expenses can include having more employees than you need, renting a premise when you could work from home, and purchasing excess stock. Turning to additional funding to keep on top of these unnecessary expenses is debt that should be avoided.
Understanding what types of debt are bad or avoidable can often be difficult for small business owners. This is where partnering with reputable accounting services can be your best decision for your small business. Accounting services can objectively review your expenses and highlight what is excessive or unnecessary, help you craft and maintain a budget that allocates income to an emergency fund, and avoid debt incurred by poor financial management. Accounting services are essential for choosing the best debt that will benefit your business.
SureBooks Accounting Services:
SureBooks is your reliable and trustworthy small business accountant. We offer payroll and accounting services that will be a successful partnership with your small business. If you are looking for accounting services that will assist you in all aspects of your business finances, including your business debt and future decisions regarding debt, then SureBooks accounting services are for you.
At SureBooks, we are dedicated to assisting your small business with growing to its fullest potential with our accounting services. Our accounting services ensure that at every step of our financial management, we are working towards growing your bottom line. This is why we take small business debt seriously, and why we will always offer you the best advice on debt tailored to your specific business with our accounting services. Our accounting services will guide you away from avoidable or bad debt and provide you with accurate and reliable advice when selecting good debt for your business.
No matter your type of small business debt, it needs to be financially managed by expert accounting services. Most importantly, efficient and effective financial management is one of the key aspects to avoiding bad debt for your small business. Our accounting services are offered by qualified and experienced accountants. Our high-quality accountants paired with the use of the latest accounting software, Xero, ensures that we can offer your unmatched financial management at an expert level with our accounting services.
SureBooks accounting services will keep your business financially on track by advising on what unnecessary or bad debt to avoid and on only selecting debt when it will ultimately benefit your business.