Debt is usually perceived as a bad thing for both businesses and individuals. Too much debt can affect a company’s cash flow and operational ability making it difficult to pay employees or suppliers on time as well as purchase stock and pay the bills.
If a company is unable to pay its debts as they are due to be paid to creditors, it can face going into liquidation or filing for bankruptcy.
High levels of debt may also cause shareholders to demand higher returns on their investments as they face greater financial risk and will be last in line for being paid in the event of bankruptcy.
However, a certain level of debt can be good for business, and in this article, we will look at some of the benefits debt can provide.
Debt Can Help Your Business Grow
Businesses can often find themselves needing more finances to fund their expansion. This barrier to business growth can be overcome by taking on debt in the form of a bank loan, line of credit, installment loans, or private loans.
This will give a business the cash injection it needs to afford new equipment, hire new employees, or increase its marketing efforts. In this instance, debt can be a practical and sensible solution to funding a business’ growth.
Debt Is Cheaper Than Equity
There are many ways to finance a business, such as using existing cash reserves, borrowing money, or issuing equity.
Equity investors expect to earn a high return on their investment, whereas debt can usually be financed at a much lower rate making the cost of equity higher than the cost of debt. Debt is also cheaper than equity because any interest paid is tax-deductible.
Debt Can Help Cash Flow Management
One of the challenges businesses face is maintaining a positive cash flow. While they may generate a profit, more than their monthly or quarterly income may be needed to balance their cash flow during certain times of the year.
This is especially so with seasonal businesses that compensate for slower periods by making most of their money during certain months of the year.
Debt in the form of a bank loan or an affordable line of credit can give such businesses the cash flow needed to buy necessary stock or equipment during less busy periods.
Debt Can Build Business Credibility
Just as individuals build their credit rating by maintaining good borrowing practices, borrowing money can help a business build its relationship and financial standing with banks and other financial institutions.
Paying off any loans on time helps engender trust in your business, making it easier to borrow money when you need it and extend your credit facilities and overdrafts.
Applying for a loan can often be a rigorous and time-consuming process for a business. Building an existing relationship with your lender will increase their confidence in your business and its ability to meet repayments on time, making the borrowing process easier and quicker.
As this article highlights, there are many instances where debt can be a great way to grow your business and meet its funding requirements.