Good debt is debt on assets that are earning income for you at a rate greater than the cost (interest) on the debt. Large corporations use something called the hurdle rate to determine if an investment is worthwhile. The hurdle rate is simply the cost of capital. If the hurdle rate is 15%, then only investments or purchases bringing in more than 15% would be considered “good debt.” If you are using a credit card for “good debt,” you better have a great return!
In addition to positive returns, good debt includes anything you truly need but cannot pay for in full without wiping out your cash reserves. From a cash flow perspective, however, you should only take loans for which you can afford the monthly payments. Purchasing equipment for your business would be a wonderful example of this kind of debt. Most equipment pays for itself with the revenue it produces, so structuring a lease or financing program with manageable monthly payments is a wise usage of good debt.
In contrast to good debt, bad debt does not create an income greater than the interest of the debt. Bad debt also includes debt you’ve taken on for things you don’t need and can’t afford. Most of these purchases don’t just fail to produce a greater return than the interest expense, they produce no return at all! Some even produce a negative cash flow. Most importantly, bad debt doesn’t help you grow your business.
Your financial success in business and life will largely be determined by your ability to discern between good and bad debt. I’ve interacted with many business owners who have problems with bad debt, but I’ve met a lot who shun all debt. Both types of business owners are going to have limitations to what they can do with their business. Embrace good debt. It will give you the leverage you need to take your business to the next level.
Article provide by Business Credit Services, Inc.