If your business is running smoothly and making a profit, there may be some instances when taking on a loan can benefit your business. Here’s a look at three scenarios when debt might be the right next step for your business.
1. Retaining Equity in the Business
When you sell equity in your business, you sell a portion of your business to an investor. That can be significant if you are expecting major growth and profits in your business. In addition, any investors become your partners, and will have a say in how you run your business.
If you take out a loan to get the capital you want, you make payments on it, along with interest. But once you repay the debt, the money that would have gone toward servicing the loan is yours. You can also deduct the interest on the loan payment as an expense on your tax return.
2. When the ROI of an Opportunity is Higher Than the Cost of Debt
Another time you might consider taking on debt is when an opportunity arises to make more money, and the potential return on investment is greater than the cost of the associated debt. For example, imagine that you own an air duct-cleaning business, and you are offered a commercial contract worth $20,000. You don’t have the equipment necessary to complete the job, and it would cost $8,000 to purchase it. If you took out a two-year loan for the equipment and paid $2,000 in interest, your gross profit for the job would be $10,000. In this case, incurring debt translates into profits that should far exceed the cost of that debt.
3. To Prevent a Future Loss of Sales
If you own a business that has seasonal highs and lows, or if your business success depends on having plenty of inventory on hand, you might consider taking on debt to ensure that you don’t miss out on future sales. For example, if you own a shop in a busy tourist city, and don’t have the cash to invest in inventory for the upcoming influx of tourists, you might consider taking out a loan to buy that inventory. Doing so would allow you to have product to sell during your busy time of the season. You can create a sales projection based on past years’ sales during the same time period, figure the cost of the debt, and if your projected profits are more than that, taking out a loan may prove a wise financial move.
Business owners can use debt to grow a successful business. Conducting research can help business owners make an informed decision about what’s best for a business.