The end of the financial year is the best time to work out the potential debts your business may incur or have already incurred.
Businesses can go into two kinds of debt – good debt and bad debt. Determining the type of debt is highly dependent on how the debt has been used for your business.
Good debt can potentially support your business’s growth and its ability to create and generate further wealth. This could be when your business purchases an asset through borrowed money that generates income for the business, with the return on investment for the asset exceeding its after-tax interest cost. If you are a business in a seasonal industry, you could use a business loan or line of credit to balance out uneven cash flow in the slower seasons.
Generally, good debt generates more value or money than the loan itself costs. It allows you to expand by financing things for the business, such as equipment, premises, skilled employees and marketing.
Bad debt may come in two forms. The first is as a loss that your business has incurred because credit has been extended to customers that cannot be repaid or recovered (which should be expensed on your income account). The second could be due to a loan that your business takes out to use for financings, such as growth or day-to-day operations.
Bad debt essentially affects the bottom line and disrupts the day-to-day activities and operations by affecting cash flow, constraining growth, and even threatening the survival of your business.
However, even good debt can become bad if not carefully managed and controlled.
Always have a plan for paying off debt in place, and try to pay off the more expensive forms of good debt before paying off the cheaper good debts. You can also speak with us about controlling your business’s debt rather than allowing the debt to control you.