Good Debt vs. Bad Debt for Your Business

Debt is a tool. Used well, it lets a business grow faster than its cash alone would allow. Used badly, it quietly eats margins until there is nothing left. The difference is rarely the interest rate alone. It is what the money does.

What Makes Debt "Good"

Good debt pays for itself. It funds something that produces more income, or saves more money, than the borrowing costs. Examples:

• Equipment that increases output or cuts labor costs
• Inventory you have a reliable track record of selling
• A second location backed by proven demand
• Refinancing expensive debt into cheaper debt

What Makes Debt "Bad"

Bad debt costs more than it returns, or covers a problem instead of fixing it. Warning signs include:

• Borrowing to cover recurring operating losses with no plan to change them
• Stacking several short-term advances, each used to pay the last
• Payments due daily or weekly that you cannot predict covering
• Not knowing the total dollar cost of what you borrowed

A Simple Test

Before borrowing, answer three questions in writing:

1. What exactly will this money buy?
2. How, and how much, will that increase income or reduce costs each month?
3. Is that monthly gain clearly larger than the monthly payment?

If you cannot answer the second question with a specific number, the debt is a bet, not an investment.

Keep the Total in View

Even good debt becomes risky when there is too much of it. Watch your debt service coverage: how much cash flow you have available for each dollar of debt payments. Lenders commonly like to see comfortably more than one dollar of cash flow per dollar of payments, and so should you.

The Bottom Line

The best time to borrow is when you have a clear use, a clear return, and room in your budget for a bad month. If those three line up, compare business funding options to find terms that fit.