Taking on debt can be an inevitable step for many businesses. A loan or a line of credit can provide a struggling business with the cash it needs to expand or fund a new venture. As with every financial move, though, it is best to consider all angles before going ahead with the decision. Here is what you need to know about when and why it can make sense to take on business debt:
When is it a good idea to take on business debt?
Businesses can benefit from taking out loans or opening new lines of credit under these circumstances:
When seeking resources to help grow the business
It takes money to make money, and a small business loan can help business owners pay for an expansion when they do not have the current resources to fund it on their own. The funds can help broaden the company’s line of products or services, pay for a move to a larger location, fund a marketing campaign or hire additional staff.
Before taking on debt for this purpose, it is important for a business to first measure the anticipated return on investment (ROI) for the debt. The ROI for taking on new debt needs to exceed its post-tax interest costs for the debt to be profitable for the business. For example, if a business takes out a loan to pay for new equipment costing $10,000 that will enable it to sign a $20,000 contract, it needs to ensure that a loan won’t cost them more than $10,000 in interest and other fees. Otherwise, the business will not stand to gain from taking on new debt. The profit margin also needs to be generous enough for it to be worth it for the business. If the final gain is minimal, the business owner may be better off investing energy in another lower-cost endeavor.
When trying to build credit
Opening a small loan or a line of credit can be a great way to build a business credit profile. It can also strengthen financial institution relationships. Small loans and lines of credit can help a business prove it is responsible and trustworthy for repaying debts. This will open the doors to larger loans that may be needed in the future.
When taking on debt, for this reason, it is important for a business to run the numbers and to be sure it can handle the monthly payments, even before the anticipated boost in revenue. If a company cannot meet its monthly payments, taking on new debt can wind up doing more harm than good to its credit.
Why is business debt often a preferred source of funds?
Businesses in need of extra cash can choose from several options. Primarily, a business can decide to sell company equity, open a small business loan, or a line of credit. Here is why debt can be a preferred source of funds for businesses:
It has lower financing costs.
Unlike equity, debt is limited. Once the loan is paid back, the business owner can forget it ever existed. On the flip side, selling equity in a company generally means forking over a part of the profit for as long as the business exists. (It is important to note, though, that debt has fixed repayment costs as opposed to equity stakes, which are determined as a percentage of the company’s profit. This means a business owner will need to pay back debt regardless of the company’s success.)
Business debt provides tax advantages.
Business debt can decrease a company’s tax liability by lowering its equity base. As an added bonus, interest on business loans and lines of credit are usually tax-deductible.
It mitigates risk.
Taking on debt to access funds, instead of selling equity, lowers the company’s risk if the business doesn’t succeed.
If you’re ready to take out a business loan or a new business line of credit, we can help! Our business loans and the lines of credit feature favorable rates and easy terms. Call, click, or stop by United Texas Credit Union today to secure the funds you need to grow your business.
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