Many companies prefer to take on debt financing than equity financing for some reasons. Why then is debt good for a company? You might have come across people talking negatively about debt. There is some truth in that. But, if well managed, debt can be beneficial to your company. However, it is wise to borrow when necessary. Don’t get into debt for the sake of it. Find out if your company really need to take on the loan before you can borrow.
Disclaimer: We do not encourage our readers to get into debt, unless it is very necessary. Do due diligence before borrowing. Consider interest rates and seek to get full disclosure of the loan before borrowing.
In this article, we are going to focus on whether it is good for a company to take on debt.
Why is it Good for a Company to have Debt?
Debt is perceived negatively, but in many ways, debt can be beneficial to your company. This is why debt is good for a company.
1. Build Credit Score
You need good credit scores to get loans at lower interest rates. One of the ways to build a credit score is by borrowing and repaying debt in good time. You can start by taking small loans and repaying them in time. When you have good credit scores, lenders will be willing to approve your loan requests in the future at lower rates.
2. Debt Increases the Rate of Company Growth
It can take longer to grow your company using revenues from your business. Lack of access to capital slows business growth. However, if you want to speed up the rate of growth for your company, you can borrow money and use it to grow your company. You can use a loan to buy equipment or hire more employees to increase production. In return, this boosts company profitability.
Read more: Good debt vs bad debt for small businesses.
3. Debt is Cheaper than Equity
You can grow your business in different ways like using cash from your business, money from investors, or borrowing from a financial institutions. Growing a company from business reserves can be slow and can leave you with no money to meet day-to-day operations.
Equity on the other hand is expensive and leaves you with less control over your business. It is because the investors will have a say in the business and they also expect good returns from the business. Investors will require at least 10% on their investment. However, debt can help you grow your business without losing control over your business.
4. Interest is Tax Deductible
The cost of debt is tax deductible when filing your company returns. You can use debt to lower your business’ taxes. You can add interest on debt as an expense and lower tax payable when calculating profits for your business. This is unlike dividends paid to equity holders which are not tax deductible and are payable from after-tax profits.
5. Debt Helps You Avoid Cash Flow Issues
Any business needs to maintain positive cash flows to succeed and meet daily operations. However, even for profitable businesses, the amount of money they make sometimes is not enough to fund their growth. If your business does not have enough money to meet day-to-day operations, you should consider borrowing.
6. Debt Helps You Build Credibility
Debt helps you build relationships with financial institutions and other lenders. When you want to borrow money from other lenders, it is easy for them to lend to your company if they see they are not the first ones to lend to you. It gives them the confidence that your business is credible.
How Do Companies Benefit from Debt?
There are many ways companies can benefit from debt. Some of the benefits of debt are that they lead to rapid growth that might not be possible when using business revenues. Besides, the cost of debt is tax deductible and you don’t have to give ownership of your company to investors, which is the case with equity financing.
However, the downside of debt for a company is interest payable. When you borrow, the amount you repay is usually higher compared to the amount you borrowed because of interest.
Read also: How to use debt to create passive income.
Is it Good for a Company to take on Debt?
Before taking on a debt, you need to consider several factors like your credit score, risk tolerance, and your business forecasts. It is because taking a loan will affect your credit score. Besides, seek to find out if your business is in a position to repay the loan. You can look at your business projections and determine if your business is stable.
There are some instances when it is not advisable to take on business debt. If your business is not in a position to repay the loan, or when the debt outweighs the return on investment, do not get into debt.
Disadvantages of Debt to a Company
Although debt is beneficial to a company, it also has its drawbacks. They include:
- Debt attracts interest and sometimes the rates can be high
- Payment on debt must be made even if the company is making losses
- Debt can be risky to a business with inconsistent cash flows
Summary of Why Debt is Good for a Company
If you are seeking to grow your company faster, you might need to consider borrowing a loan. A debt is beneficial to a company in that it helps your business avoid cash flow issues, it is tax deductible, and can help build the credibility of your business. However, before borrowing, make sure that your business is in a position to repay debt and that its returns are higher than the debt.