Debt sounds scary and is often perceived as something that nobody would willingly want to cross paths with.
And businesses are no different. Most of them think that borrowing money means your business is struggling and this stigma stops people from realizing the fact that debt can actually be used to grow your business.
Yes, yes. We hear you. Debt can be harmful. But it’s harmful only when it’s not managed intelligently and gets out of control. That’s why you need to keep an eye on your credit report with ClearScore and make sure that it stays healthy.
But for now, let’s explore 4 ways that you can use debt to grow and transform your business.
1. Debt Leveraging allows you to Grow Faster
Debt leveraging is an investment plan that uses borrowed capital as an investment to expand and generate greater potential returns from an opportunity.
For instance, a business can use debt to acquire new equipment, buy an extra piece of land, increase its inventory, or develop a new product. All of this can then be used to increase sales and profitability.
The only catch is that doing any of the above with borrowed money should result in a greater return than the cost of borrowing that money.
Here is an example of how debt helps you grow faster.
Firm A and firm B both want to buy new machinery that will allow them to increase their sales by 100%. For the sake of simplicity, let’s assume that the profit will increase proportionally with the sales. This machinery will cost $200,000 and both firms earn $50,000 per month.
Firm A, using its current sales level, qualifies for a loan of $200,000 at a 10% interest rate.
Firm B, on the other hand, decides to fund it from their equity and starts saving up for the machinery. Assuming it can only spare $10,000 per month, it will take 20 months for this firm to buy the machinery.
After 20 months — when firm B would have just finished saving for the new machinery — firm A would not only be selling almost double but would also be $780,000 richer than firm B ($50,000 x 20 minus interest and loan).
2. Debt doesn’t Require you to Give up a Stake in your Business
There are lots of financing methods that you can use. But most of them require you to give up a stake in your business, which means you’re going to get a smaller proportion of all the future profits you’re going to make.
For example, let’s assume that you are considering partnering up with another company, Z. What will happen? You are going to give up some of the ownership control to that company in return for receiving investment.
The same is the case with any kind of equity financing. You agree to exchange shares of your business for upfront capital. This means that if after buying a piece of equipment through equity financing you start earning more, you’ll also have to pay more to the people you’ve sold your shares to.
And here’s where debt becomes super-useful.
You just agree to pay a certain amount of interest for upfront capital, regardless of how much you increase your earnings through debt financing. This means that even if your earnings get doubled, you won’t have to pay a single penny more than what was initially agreed. Plus you retain 100% ownership control over your business!
3. Interest doesn’t get taxed
You might be thinking of the high-interest rates that you’d have to pay if you loan out a big amount.
In reality, the cost of borrowing is not as high as it may seem. This is because interests on most loans are actually tax-deductible, which reduces your taxable income.
Thus the cost of borrowing money is a lot less than what interest rates might suggest from the outset, making debt financing very cost-effective.
Another reason you don’t have to worry about interest rates is that debt, when invested for the right purpose, earns you extra profit that can be used to pay it off.
It’s as if the debt is paying for itself without you having to sacrifice your initial profits. In fact, a good debt-financing plan will increase your overall profits.
4. Debt financing allows you to Build a Solid Credit History
Credit history is important. It reflects how responsible you’ve been at repaying debt. A good credit history would include on-time payments and not owning large amounts of debts.
Credit history is what lenders are interested in before they loan out money. A solid credit report means you’re a low-risk borrower, which may convince your lenders to loan you money at lower interest rates.
When you apply for a loan, make sure your credit record is clean and healthy. This will make the process of getting loans in the future much easier for you.
Another perk of a healthy credit report is that it can get you an increased spending limit. This means that you can loan out a larger amount, allowing you to have an even larger leveraging effect on your profits.
Now you know how you can use debt to your advantage. However, don’t jump into debt financing until you have an extremely good plan about how you’re going to use that debt to multiply your profits. Because without a solid plan, this strategy might land you in a tough spot!
