The Difference Between Good Debt and Bad Debt.

Adrian Ludwig -Account Executive, Crest Capital - 11/26/2008

The Difference Between Good Debt and Bad Debt.So… all of a sudden, "Debt" has become a dirty word. Really – turn on the TV, go to any financial or news program, and you'll see talking heads discussing debt, and how bad it is… Debt is bad for consumers, debt is bad for businesses, debt is bad for the country, debt is bad for your waistline… Etc etc. Debt even shoulders the entire blame for the current economic crisis. It almost seems implied that if it weren't for that evil, evil debt, we'd all be riding yachts on rivers of chocolate, wistfully frittering our days away on the pleasures of life. But instead, because of debt, we're going to have ANOTHER DEPRESSION; replete with the world turning a grainy black and white while we stand in line for hours on end for an apple. Ok, time for reality check. First off, that's not's going to happen. Secondly, not all debt is bad – not by a long shot. There is a marked difference between good debt and bad debt, and smart companies can tell the difference. In fact, by taking on good debt, nimble companies may just find that they come out WAY ahead. Good Debt (aka Smart Debt) vs. Bad Debt It's essential to understand the difference between Bad Debt and Smart Debt (we're going to call it Smart Debt from now on, because that's what it is). In good economic climates, both forms of debt are acceptable. But in tight economic times (like now) "bad" debt is deadly, but smart debt becomes almost essential. Examples of Bad Debt: Bad Debt is debt taken on for disposable or discretionary items and services that are not essential to running the company. Good examples of bad debt include borrowing to pay for non-essential inventory, non-essential payroll, elective services or supplies, and the like. If the company is cash poor, borrowing to meet cafeteria payroll or buy new dining tables (for example) are probably not the best ideas. Perhaps it's best to temporarily close the cafeteria and ask people to brown bag it. Examples of Smart Debt: Smart Debt is debt taken on that creates value, revenue, or gives you positive leverage. Smart debt is debt that cuts costs, increases efficiency, or expands your market. Smart Debt is tied to revenue / profitability in some way, and helps you maintain / grow your business. Good examples of Smart Debt include purchasing core inventory; buying new, more efficient core equipment; and hiring critical personnel. When to Take on Debt: You take on debt when it is financially advantageous for you to do so. However, that might not always be clear. You have to remember that everyone is experiencing tough economic times. Use this to your advantage. In reality, in "good times", it's actually HARDER to compete, because everyone has money to spend, and is free about doing such. It's in slower economic times that companies truly separate themselves from each other. The company that can get more efficient (for example, by buying new core machinery and/or upgrading their ERP system) is actually in a far better position to separate themselves from their competitors. Taking on Smart Debt can actually be profitable. To use an already-given example, upgrading to a new ERP system via software financing can result in efficiency savings that exceed the finance payments. The new software saves you "X" a month, while your payment is ("less than X"). It doesn't take a mathematician to tell you that's good business. The same can be said about new machinery, new inventory, new personnel, etc. In fact, it would make almost no sense to NOT take on that type of debt. RECOGNIZING that is what separates companies that strengthen themselves during tough times from those that die a slow death. The weak company says "freeze everything, and no more debt at ALL". The smart (and strong) company says "how can we use Smart Debt to grow?" Who is doing well today?? We hear this question a lot. And as equipment financers, we can tell you that while no industry is immune to the downturn, companies that are taking on Smart Debt to expand / get more efficient are doing remarkably well. Adding "revenue-producing" and/or "expense-reducing" equipment, as well as upgrading software, are allowing these companies to take advantage of weakened competition. They will emerge from hard times strong, while the competition may not emerge at all. ------------------------------------------------------------------------------------------------------------------- Crest Capital is an Equipment Financing company that provides fast, easy, low-interest equipment financing and equipment leasing to small and medium sized businesses, even in these tough economic times.