Imagine you’ve successfully attained a business loan of 50 thousand dollars. The ethical thing to do is to spend it with the objective of increasing the companies’ net worth. But what and how exactly do you go about doing it?
According to Brad Botes, bankruptcy attorney, Founder and President of Bond & Botes, debt incurred for financing sources that ‘creates positive returns’ falls under this category. This includes the purpose of purchasing inventories, whereby it translates to sales, which in turn means an increase in profits.
Another example would be loans for the purpose of employment. Hiring essential and relevant people to help with the company’s process would improve its efficiency and thus has a positive effect on the business.
So, you may say, “loan spent on getting a personal car translates into positive returns for the company because it improves the personal image of the CEO, thereby attracting more clients”. Well, read on to find out if that’s the case.
In short, bad debts are considered a liability and does not generate value. These includes repayment of credit debts, loan for personal luxury, etc.
Having said that, some bad debts are unavoidable, for instance, litigation and medical reasons. ‘The key is to ensure that you incur bad debts only under these necessary circumstances’ (Dollars & Sense, 2018)
So back to our question- should we purchase a car with the loan? Well, there isn’t a fine line between. It does not generate any business benefits if you drive it on a weekend for personal entertainment. But perhaps you use it at time to meet clients. “Bad or good debt?”, you may ask. At the end of the day, it boils down to responsible management of debt.
Before we end off…
In investment sense, a ‘good debt is a form of debt which more than pays itself’ (Dollars & Sense, 2018). In other words, they are loans that allows you to reap monetary benefits from it. Hence, debts are not always bad and can be important at times for the business to generate revenue.
So, our bottom line is, if you have a good project, go and take up a loan. Results always come with a risk; don’t be too conservative if you want to make something big out of it. Essentially, take on debts that you are able to handle.
Written by Nikita Ng, Business Associate @capmarket