As business owners, taking on debt can be an effective of managing your cash flow. Whether you need it for business expansion (eg. hiring more people, buying more supplies, getting a bigger office space), or simply to provide peace of mind in case of unexpected delays in customer payment collection, external capital injections are an important part of operating any business.
When your business should take on debt
From a cost perspective, business loans may be a cheaper form of financing than you think. The IRD in Hong Kong and IRAS in Singapore allows businesses to deduct the interest on the debt from income taxes. Debt may also be a cheaper form of financing than selling off a portion of your business where new shareholders/investors may demand dividends or short-term returns on their investment, and sharing control with them.
According to Jeb Ory, CEO of social advocacy group Phone2Action, taking on debt is a stepping stone to the growth of many companies.
“Access to capital can be the difference between explosive growth, linear growth and the death of your business. Debt should be used to extend runway and help businesses make purchases that they couldn’t normally make if it makes them more competitive.”
That being said, we know that the accumulation and mismanagement of debt can be a leading cause of financial troubles or even bankruptcy for small businesses. So it is important for you to know when you can consider it safe to take on debt.
You should take on debt if you can identify yourself with the following scenarios:
1. When you understand the different types of debt and their respective borrowing terms
Previously, we’ve talked about the various types of cash flow management solutions and the differences between loans vs. lines of credit. Different types of debt comes with different interest rates, repayment periods and general borrowing terms. Understanding the different options and how it relates to your business going forward is an important step before you take on any debt.
2. When you have established a plan for how to use the funds and how to repay the funds
To stay ahead of increasing competition or changing macro level trends, you should have a business plan for which areas you’d like to invest in before taking on debt.
- Is it related to new lines of product or service?
- Perhaps you’d like to take advantage of digital marketing trends and increase your spend on Google or Facebook?
- Maybe you and your team are overwhelmed with work and the business would benefit from additional new teammates?
- Or maybe, your inventory are flying off the shelf so you just need additional capital to buy more goods。
Whatever the reason may be, it’s important to have a measurable process in place before you take on debt. This way, you are also better setup to evaluate whether the return on investment related to the debt was worthwhile.