Acquiring debt is often considered to be a negative aspect for the growth of a business. However, finance experts don’t count on all forms of borrowing as bad. Small business owners should keep a few important things in mind even when they don’t possess a degree in finance.
Debt often helps business owners gain leverage in the following ways:
1. Debt is not as expensive as losing out equity
You may achieve capital from a number of investors, but in that attempt to fulfill your short-term need you’re actually restricting the scope of future profits. The cost of interests that you incur with debts is limited and temporary. Your equity is bound to remain unaffected as you repay the amount. Acquiring debt is much better if its costs are smaller than the combined cash flow that you’re losing out on your equity investment.
2. Meeting the debt interest lowers tax burden
Borrowing yields a few surprise benefits that the entrepreneurs aren’t aware of. Much of your expenses towards meeting taxes get curbed as your taxable profit are reduced by the cost of interest. As a result of this, the nominal interest that you ought to bear is higher than the effective interest. Thus, while calculating the return from acquiring debt, you must consider the smaller cost of capital. Factoring of this lower cost assumes both selling of equity as well as borrowing to be the means of funding your business expansion.
3. Debt costs lesser than the opportunity cost
There are times when a business owner fails to buy inventory due to lack of capital. For instance, imagine a situation wherein you can sell your product for $30,000 after filling out your inventory gap at the wholesale cost worth $10,000. Now, will you bear a cost of $2,000 for borrowing the amount of wholesale cost and fulfilling your order?
While calculating the APR on your loan, you’ll realize that a loan that is obtained for 2 weeks and demands an APR of 520% is still better than bearing a 20% APR on a year-long loan. The investment that you make yields a fairly high ROI against the 520% APR; so that’s a profitable business. However, you must read through the fine print thoroughly as the clauses may vary from that of the online installment loans that you use so frequently.
4. Debt makes a borrower more disciplined
This is a fact that’s often overlooked by small businesses, although the private equity firms are well aware of it. During the initial years of formation and growth, an organization learns how every investment and expense needs more discipline, especially while coping with debt. However, discipline isn’t just about resolving debt issues; it’s actually a positive outcome of resolving them.
There’s a reason behind it. Once you possess more cash in hand, the extra benefit of optimizing each dollar gets minimized. You may look forward to things that are nice-to-have once you’ve gained possession of all necessities. On the contrary, when you’re on a tight budget, the spending bar gets raised since your transactions and business decisions seem justifiable financially.
Compared to the other funding options, acquiring debt can be a strategic tool for a growing business as it’s quite inexpensive. However, you’ll need to get the combination right with all of your decision-making tools if you really want your business to explore its full potential. This, in turn, will help your business sustain within a competitive environment and keep all challenges at bay.