Is there such a thing as Good Debt?

It's all about the purpose

While business borrowing should always be considered carefully, there are situations where borrowing can be positive for a business.

When debt has a specific income producing purpose, such as to purchase or produce stock to meet additional demand, or to purchase income producing plant and equipment, then debt acts as a business catalyst. Broadly speaking, if the additional income from the debt  exceeds the interest on the debt, and repays the debt over the long term, then the borrowing has facilitated long term business growth and has been positive.

If, on the other hand, debt is used for non-income producing purposes such as personal expenditure, or to simply repay other debt, then the borrowing hasn’t contributed to the overall value of the business, and has probably been detrimental.

Ability to service and repay the debt

With most types of debt there will be a requirement to provide some form of security, whether a charge against the assets of the business (or a specific asset) or a personal  property. In the event that you are unable to pay the interest or principal the lender may seek to enforce and take possession of the security.

Debt should therefore only be added if you confidently have (or expect) the ability to both service the debt (ie pay the interest) and repay the principal over the term of the loan. The downsides for late or non payment can be significant.

Term

To the extent possible borrowings should be matched as closely as possible with the cash inflows from the business.

A significant mismatch can gain lead to serious problems  – for example funding a long term investment project with short term debt could lead to a cashflow shortfall.

In summary

Business finance (ie debt) comes in many forms, and can be either positive or negative for a business. Debt is “good” when used to invest in the income producing assets of the business, can be properly serviced, and is matched to cashflows. If these basic conditions aren’t met then borrowing is probably not the right course of action.