There are plenty of contributing factors when it comes to debt decisions, but for the purpose of this article, I’ve zeroed in on just THREE. That is, THREE debt issues business owners need to carefully consider and the top THREE scenarios that cause smart (business) people to make dumb debt decisions.
Succeeding in business (and life in general) is often closely tied to debt attitudes.
Too ‘gung-ho’ and you’ll quickly find yourself up to your eyeballs in impossible to meet repayments. Too conservative and the opportunities to prosper will pass you by.
The fact is, if you want to succeed in business you need to be clued up about debt.
Debt is a friend that can help you to grow your business. It can acquire quality assets and grow your personal wealth for shoring up your retirement lifestyle. It can also allow you to indulge in personal pleasures – fast cars, big boats, luxury homes.
I’m not saying you shouldn’t take advantage of debt to enjoy the finer things in life, BUT! it will quickly turn into your arch enemy, if you fail to consider these THREE important debt matters – timeframe, total costs and ROI.
Before I explain these, let’s look at THREE typical scenarios that cause decision-makers to enter serious debt territory.
Scenario #1 – Start-ups and new businesses
Whether the business was borne of an innovation that’s still in development or a former employee finally decided they can do a better job than their prior employer, many new business owners quickly discover the money needed for equipment, rent and to pay themselves isn’t flowing as quickly as they’d hoped. The fantastic plastic, even at a whopping 20-something percent interest rate, is used as a fast fix for their immediate cash problems.
Scenario #2 – Maturing businesses that are starting to hit the good times
These business owners have worked hard. They’ve turned a corner and they’re finally enjoying regular cash flow. It’s payback time. After all the sweat and tears, it’s okay to splurge a bit, upgrade the car and buy that fancy house. They’ve earned it – right?
Scenario #3 – Private home upgraders and personal ‘asset’ buyers
The business is well established and for the most part income and cashflow are pretty steady. The business owners feel confident taking regular drawings, so they take a loan (that’s a bit more than they should) to upgrade to their dream home, buy a luxury motor vehicle or a boat for cruising the harbour.
Typically, these scenarios are precursors to THREE critical debt errors relating to:
- loan timeframe
- total cost of the loan, and
- ROI – return on investment
Business owners who get themselves into debt trouble, often fail to plan the timeframe for the life of the debt. This impacts directly on the cost of the loan, as the longer it takes to pay the loan down, the more the interest piles on.
Then there’s the matter of whether the purpose for the loan will deliver a worthwhile return on investment. If it’s a private residence (or another private asset like a car or boat) there is no tax off-set advantage nor is a private residence (car or boat) an income producer. No ROI here!
Even worse, if the home is purchased at the top of the market, then values dip. Your choices will be to ride it out and hope the former value is regained or you sell and take the loss on a sale price that’s not enough to fully pay out the debt.
However, if the loan is to provide cashflow until a valuable contract payment lands in your account, it is for equipment that will take your operation to greater levels of efficiency and production, or you’re buying an investment property that can be rented to tenants, then that’s a whole different story. This good debt for good investments that will likely provide future income generation and tax efficiencies.
The key to good debt decision making is to understand the cost of the loan, over a pre-determined timeframe, for tax-efficient and/or income producing purposes. Then, when forecasting your financial position, ensure adequate buffers are factored in for any unexpected challenges.
You should think carefully when choosing credit cards as a finance source. Yes, they are convenient, but unless you pay the balance in full at the end of each month, the sky-high interest rates required by most credit cards can create a rat-wheel of compounding bad debt that you could find difficult to get off.
The smart approach is to use debt strategically. Control it, rather than allowing it to control you.
To avoid dumb debt decisions, consider these tips:
- Clarify whether your debt (existing & proposed) is helping you achieve your bigger picture financial goals
- Forecast and establish the amount of debt and timeframe necessary for achieving outcomes
- Before you lock yourself in, know how to get out – understand the T&Cs
- Choose the lender and the type of finance that’s fit for purpose
- Consider affordability and factor in a cashflow buffer that will help counter unexpected financial challenges
- Consider restructuring existing debt to eliminate or reduce bad debt (non-tax deductible or non-ROI producing debt)
- Learn how to utilise the current low-interest environment to purchase quality assets that can create future positive-cashflow or future income streams (in retirement)
- Understand that the total cost of an asset = cost of asset + cost of interest + debt fees & charges
- By all means treat yourself to the finer things in life, just understand that these often expensive ‘things’ will more likely be depreciating than appreciating assets
- Get advice and implement a debt strategy that’s considers both your business and personal debts
If you found this article helpful, and you need advice for implementing good debt strategies so you can succeed in business and enjoy personal prosperity, please contact me on +61 2 9699 9171 or email shane@makecentsaccounting.com.au
This information (including taxation) is of a general nature only and neither represents nor is intended to be personal advice on any particular matter. Make Cents Accounting strongly suggests that no person should act specifically on the basis of the information in this document, but should obtain appropriate professional advice based on their own personal circumstances.
