Much as the crane pictured to the left can be dangerous in in-experienced hands, so can debt. However, just as the building pictured could not be built without use of the crane, it is often difficult to build a thriving business without the use of debt.
Most best practices for personal financial management encourage the reduction and avoidance of personal debt to the extent possible. This is rightly so as most personal assets acquired with the debt do not help add to a person’s individual income generation. However, in business debt is typically incurred to help facilitate growth.
The traditional view of business debt I hear small businesses talk about are term loans which are used to purchase equipment, buildings or property. However, one of the most crucial assets a business can have to facilitate growth is often ignored when talking about debt financing. This asset is Working Capital.
Simply put, working capital is the amount of cash or cash-like assets (accounts receivable) you have that are in excess of any debt that has to be repaid in the short term (accounts payable & loan payments due in the upcoming months). Without this working capital it is hard for a business to take advantage of opportunities which occur in their industry or survive un-foreseen circumstances.
For example, if a company has excess working capital they might be able to hold pricing firm in a declining market for a period of time. This would cause inventory quantities to increase in the short term (i.e. turning cash into inventory) due to a decline in sales but they could also avoid losses on the sales of their inventory while waiting for the market to strengthen back up.
Here is where the concept of debt as a tool comes into play. If a company does not have sufficient working capital to take advantage of a situation, they at least need to consider debt financing as an option vs ignoring the opportunity. This debt could come in the form of a term note, a draw on a line of credit, or some other form of borrowing. However, the decision does also not need to be blindly entered into.
To effectively utilize debt a company needs to also look to its budgets, cash forecasts (both of which are additional tools) and external market factors (i.e. when do we expect the market to strengthen again). The company needs to be aware of upcoming expenditures and any trends in the market to determine the feasibility of taking advantage of an opportunity. The last thing we want to happen is to forgo a previously planned expenditure because we lost sight of our long term vision to take advantage of a short term opportunity.
In conclusion, debt needs to be a tool which is in every company’s “toolbox”. However, the debt must be supported by other “tools”, which must exist prior to an opportunity presenting itself, to be effective. I encourage you in 2017 to add to your business’s toolbox and not just use the same approaches which have always been used.
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