When It Makes Sense to Take on Debt

Optimistic business owner

If you own a business, you probably spend a lot of time considering your cash and costs. As a business, cash ensures you can pay your bills and avoid bankruptcy. So why would it ever make sense for your business to take on debt? After all, avoiding debt and achieving financial independence is often seen as smart business practice.

But is it really? The truth is: not always. In fact, debt is often essential to business success. After all, if you run a company, at some point you’ll need an injection of cash to purchase inventory, equipment, or expand. Taking on debt to fund these ventures can result in a huge payoff, increasing profitability and improving your cash flow.

But how do you know whether you’re staring a good investment opportunity in the face—and if it warrants taking on debt?

Mike Michalowicz, author of Profit First (which teaches entrepreneurs how to transform their business from a “cash-eating monster to a money-making machine”), shared with us his tips for recognizing when it makes sense to take on debt.

Identify areas that are consistently profitable

Avoid taking on debt if the opportunity isn’t worthwhile. To do this, identify the elements of your business that are consistently profitable and have a predictable return on investment. If you borrow money today to do more of what is already profitable, you’re likely to make a massive return tomorrow, explains Michalowicz. “The key to taking on debt is funding what is already proven to work.”

Now, magnify what’s going well

Once you’ve identified what are you doing right, and what are you doing wrong (i.e. what’s not working for your business and is removing profitability from it), magnify the former.

For example, if you are looking to purchase a piece of equipment that can manufacture a part quicker and more accurately than can be done with manual labor—that’s a prudent investment, because the outcome (faster product manufacturing and more sales) is predictable. “When you have a predictable return on investment—that’s where you invest your cash,” says Michalowicz.

Plus, by focusing on doing more of what is already profitable, you’ll also increase your chances of getting your funding request approved.

Be selective about your debt

If you decide that now is the time to invest in your business or you have a worthwhile growth opportunity that can’t wait, you’ll need to find the right financing. This is another important element as you consider whether to take on debt. There are many options out there and not all loan products are created equal. For example, traditional bank loans and lines of credit can be difficult to obtain and require lots of documentation to support the application.

Why? Commercial lenders have made access to credit incredibly challenging for small business owners by requiring hours of paperwork, high FICO scores, and loan thresholds that are higher than what most businesses need or want.

In addition, it can take weeks for traditional small business loans from the bank or SBA to be approved. Alternatives, such as Fundbox (which Mike Michalowicz uses for one of his companies), can provide faster credit decisions online. If you’re approved for Fundbox, funds can be drawn any time and are available as soon as the next business day. Learn more about how Fundbox works.

Disclaimer: Fundbox and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.

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Tags: Financing