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phanio
01-17-2009, 01:53 PM
I have only been on this forum for a short period, but I have run across several comments for poster stating that they hate debt and will do everything possible to avoid it.

I want to take a few moments to dispel some of the myths about debt. I am not trying to sell anything here – just want to demonstrate that debt can be a great way to take advantage of opportunities that will arise in growing your business – as long as it is managed properly!

Two examples:

First, take a small business that earns $10,000 per month in profits. Now, an opportunity arises where this business could purchase a second piece of equipment for $120,000 that would double the business and its profits. This business could save its monthly profits and purchase the equipment in a year from now – assuming that the opportunity has not disappeared. Or, this business could leverage its monthly profits, take a loan, and buy the equipment now and realize the additional business or take advantage of the opportunity NOW. The business uses its current earnings to qualify for the loan and then uses the equipment to pay for itself. This is called leverage.

(Note: does not have to be just for equipment – could be working capital to bid and win a large customer, to change location that has better traffic, or even to complete a big order that was just received).

Now, in 12 months, let’s look at this business. If it did not take the loan, it would still be earning $10,000 per month but could now purchase the equipment outright and begin (get started) taking advantage of the opportunity. If it took the loan and bought the equipment 12 months ago, it would be earning $20,000 per month less the cost of the loan (say $4,000 per month for an 8%, 36 month facility). Thus, it would have earned $6,000 per month more over the last 12 months (or $72,000) had it taken the loan. So is this business better off? Instead of having the $120,000 and the ability to buy the equipment, this business could have the equipment and $192,000 in the bank to take advantage of again more opportunities.

Second, seasonal businesses tend to earn the bulk of their revenue during their peak season (say a month, a quarter, or a season like the summer months or over Christmas). During the season, the business does well but limps along throughout the rest of the year. This business could leverage its peak earning season for a line of credit that gets it through the rest of the year. With this line of credit, it could take advantage of other opportunities that arise - off-season – further growing the business. I have even seen companies take a line of credit to minimize tax requirements. In Texas, there is a franchise tax where the State taxes the assets of a business that are on the books at year-end. I worked with a company that would pull out all the cash the business generated during the year (as the owner paid a lower personal income rate) and use a line of credit to meet the expenses of the business until the company was able to rebuild its cash reserves (usually took the first three to four months of the year).

The idea with debt is to:

1) Manage it properly, and
2) Ensure that what the funds are used for pay for P&I on the loan.

As a former commercial lender, I would see five companies a day request loans but have no idea how to pay them back.

Every successful company in this country and around the world has used leverage to grow their business to the successful companies they have become.

Additional, debt, if the funds are used to pay for themselves, are a great way to keep your current cash in the business (working capital) while growing your operations.

I guess I am trying to say that debt is not a bad thing – usually is a great way to grow a business – provided that it is understood and managed. Imagine having the funds to bid on jobs or land customers that eluded you in the past due to limited working capital or a weak balance sheet.

I would really like to hear your specific reasons for not using debt in your business. I have found that many people dislike debt because they just don’t understand it. Maybe through this post, we can further clear up some misconceptions and shed light on its use and benefits. I am sure there are others here that have great stories about using debt.

vangogh
01-17-2009, 03:30 PM
Great post Joesph. I agree with you and don't have a problem taking on debt for the long haul. I actually used my credit card to help pay for things when I was first starting out, knowing that while I could pay at that moment that some of the things I was buying would help me take in income that would allow me to pay back the money and that as my business grew I'd be able to pay back the rest.

I think many small businesses owners feel uncertain about ever being able to pay back the money. For some it may be that they still lack confidence in their business at first. Later when they see it bringing money in it's easier to see that it will come in again after.

Some people only see the cost part of the equation, though. It's the same thing with advertising. I hear people all the time saying they can't afford a $500 ad, but if the ad is going to bring back $5,000 in business you're really not spending anything. The hard part is there's no guarantee of what will come back into the business and I think that lack of guarantee leads to uncertainty and doubt and a lack of confidence.

Aaron Hats
01-17-2009, 04:59 PM
– as long as it is managed properly!


Those are the key words. Debt can be a good thing to help a business grow at the appropriate time but it can also bury a business.

phanio
01-19-2009, 08:01 PM
Aaron Hats - I don't agree - only the business owner(s) can bury the business. Money (debt) is only a tool to be wielded. I guess its just find the right tool to do the right job sort of thing. There are jobs that require money as the tool. If the tool gets away from the wielder – it is the wielder’s fault – not the money’s.

KristineS
01-20-2009, 03:44 PM
I agree with you Joseph. You have to manage your money and be smart about the debt you take on. Our entire economy is a lesson in that at present. People took on debt they didn't know how to manage. The result was chaos and confusion.

I think it's human nature to want to blame someone or something else though. Instead of taking responsibility it becomes the fault of the person who approved the loan, or the fault of a bad economy.

huggytree
01-20-2009, 05:09 PM
example #1...what if the business cant sell all of the new equipments time? what if it takes years to have it running 100% and you have to pay for employees to sit for 1/2 the day?....what if the economy goes bad (uhhummm) and works drops off to nothing and you cant even sell that piece of equipment that you still owe $100,000 for?

im just a 1 man business, so i dont think 'big'....everything i do i consider 'what if i go under? what would i do?'.....i dont mind taking out a loan if the rate is low enough, but i always have enough in reserve to pay it off if needed....I buy all my equipment with cash (some pieces are 4k, so were not talking much), but my work van i had a loan on and that was just because i wanted to keep a large amount in reserve...when i buy my next new van ($40k) i plan on using cash, but maybe stocks will be doing better and ill take a loan again....but i will have $40k where i can get at it if needed....im very conservative in my business...i take as little of a risk as possible always...and it works for me...

vangogh
01-20-2009, 06:24 PM
huggy I think it's good to prepare for the worst, but that doesn't mean it has to stop you from hoping for the best. All the things you mentioned could happen, but they don't have to happen.

For example could employees be hired part time instead of full time? Could there be other work they could do during the times they aren't running the machine? A bad economy doesn't have to mean work drops off to nothing.

I know the feeling of wanting to be covered just in case, but I also know that you have to take some risks to get ahead and you have to accept that some of the risks you take won't work.

phanio
01-20-2009, 07:22 PM
Vangogh, I agree – you have to take risks – but you also have to manage those risks, or at least understand what the risks are and what you are going to do about them. That is why taking on debt for a growth opportunity could be a good thing – but do make sure that if the equipment, in this case, is idle, you have other revenue to fall back on. Your lender should also ensure you have other revenue to fall back on.

Debt is scary for some people and that is probably a good thing. I just wanted to point out that there are times that debt can be good. Not all business owners have the ability to pay cash. Further, in order to grow, debt usually does come into play.

I just wanted to point out that many times fear of things, like debt, is not really based on fear but more of a lack of understanding.

vangogh
01-20-2009, 07:46 PM
Absolutely agree about managing risks. You don't want to just jump into anything, but we do agree about the debt. There are times where it's an acceptable risk to take on some debt. Maybe you invest in a machine that can double your output, because you feel confident the market can handle more product and will gladly buy it. There's no guarantee the market will buy of course, but if you've done your research well and feel confident they will you'd probably be wise to borrow the money to buy the machine.

huggytree
01-21-2009, 05:22 PM
yes some businesses do drop off to nothing in a bad economy...plumbing for example.

i know of a few medium house shops who had 12 employees...now 2

that equals 8-10 vans full of equipment sitting...losing money..i assume most of those vans are not paid for. lets say they owe $15,000 owed per van....$120,000 owed...

also the work they can get on new houses is down to cost or below...so no profit to pay for those 8 vans.....can you sell those vans right now? nope...every company is down sizing...

now think of the $10,000 in tools sitting in these vans

now think of the storage costs

these things worry me when i think of expanding some day...i will have a solution to all these things before i do it...im not going to let it happen

vangogh
01-21-2009, 07:32 PM
No question some businesses do drop off, but if you've prepared for down times you'll survive. I can understand the worry, but if you spend too much time focusing on the bad you won't be ready when the good comes around.

You have to be aware of the bad, but you also have to be ready for the good. See it as a risk assessment. Don't risk too much when it's unwise, but a calculated risk can be good for a business.

Aaron Hats
01-21-2009, 08:12 PM
Aaron Hats - I don't agree - only the business owner(s) can bury the business. Money (debt) is only a tool to be wielded. I guess its just find the right tool to do the right job sort of thing. There are jobs that require money as the tool. If the tool gets away from the wielder – it is the wielder’s fault – not the money’s.

That's ok, we can disagree. I too believe only the owner can bury a business...most of the time. Say a business has $250k in debt and easily making their payments on it. Then one day disaster strikes, something out of the owners control, and they can't make those loan payments for three or fours months which snowballs into their landlord evicting them, vendors shutting them off so they can no longer make their widgets. If they didn't have the debt or only had 1/4 of it they would've been able to get through the crisis. Instead, they're now considering bankruptcy.

vangogh
01-21-2009, 09:39 PM
Aaron maybe that meant the business owner took on too much debt. Is that the debt's fault of the business owner's fault? Is there a way to refinance the debt so payments could be made? Could some other expense be cut temporarily?

I'm not saying the answer to any of the above is easy, but some people would find a way to continue paying the debt and others wouldn't.

Aaron Hats
01-21-2009, 10:10 PM
I'm not saying the answer to any of the above is easy,

You're right. Like all problems, there's always more than one possible solution.

phanio
01-21-2009, 10:26 PM
huggytree - I understand. My question would be - why did they buy those vans and tools in the first place and why did they have 12 employees. At that time it must have been the right thing to do. This is a strange market we are in right now. Seems to only come along every 20 to 30 years. No one can really anticipate market risks – especially to the extend we are in now.

But, if those other shops felt they had the opportunity to make money with those vans, tools, and employees, they took the risk – and – hopefully it was based on good numbers in their markets. If they have managed their business for the debt, they might still be OK.

Let’s say one of these companies (Joe the plumber) was at 2 employees with two vans – 3 years ago. Joe saw change in the market and expanded. So, for two and half to three years, he was doing very well. Expanded to 12 employees and 10 vans. But, during this time, his profits should have expanded as well.

Proper financial management and understanding debt would have lead him to pay those vans off as soon as he could (as he was making a whole lot more than three years ago) – while his market was still flourishing. Or, he should have put some away for a rainy day – like now. If he did these things, no problems. He financially managed his business. If he didn’t, just took the money out and had no concern about the future, then he will pay now. Take the debt to grow, expand, and prosper – but manage for the risks.

But, I see your point, would be bad to be saddled with $120K and no means to pay it.

huggytree
01-23-2009, 01:16 PM
i have no employees and can only guesstimate what i would make per employee per year in profit...my guess is $20,000-30,000 per employee per year....those 8 extra vans/equpiment would need 2-3 years of income to break even...what if the good times didnt last 2-3 years?.....they did for most people, but depending on when you got to 12 employees it may not have been....no one can predict the bad times, so if you suddenly expanded 3 years ago(things were still pretty good here) you would have lost money on the deal...and maybe $20,000 per employee is too high..maybe its $10,000

if and when i expand i think i will put all the profits from the employees into paying off their equipment debt asap....instead of going to europe and vegas 2-3x a year like most contractors do.

Evan
01-23-2009, 10:39 PM
I generally agree that taking on debt is not a bad thing. But your example assumes that sales will increase with the new equipment (location, etc.), and that in the long-term profits will remain steady (roughly). These aren't always safe assumptions, especially in today's economy.

For example, a local printer may be able to get this real nifty printer that can print 3,600 pages in an hour, instead of only 1,000, which is a 360% increase in efficiency. Regardless of cost, your assuming that because the volume of production increases, sales can. That's not always true. But if the printer is always busy and unable to keep up with jobs, or working awkward hours to maintain his clientele, then I'd agree.

seolman
01-23-2009, 11:10 PM
What Evan is saying is so true, we can plan but we can't predict. Many years ago when the Shah of Iran was thrown out of power and the US contractors were suing the new government of Iran trying to get money out of them for canceled contracts worth billions of dollars the judge of the International courts basically told them "the risks are great and the rewards are great". In other words: "too bad".

Being in business is a risk and sometimes you win, sometimes you lose. Borrowing money to grow your business against perceived future sales is a risk. You might win and you might lose. If you are good at predicting economic and political stability, you'll have a better chance of winning. Don't forget insurance.

phanio
02-01-2009, 02:27 PM
seolman - you stated "Being in business is a risk and sometimes you win, sometimes you lose. Borrowing money to grow your business against perceived future sales is a risk. You might win and you might lose. If you are good at predicting economic and political stability, you'll have a better chance of winning. Don't forget insurance."

So correct - with debt sometimes you win - sometimes you lose - it is also true with all aspects of business - even just starting a business. If you don't beleive in your business or in yourself for that matter, then don't take debt.

I always beleive that people can adapt and overcome (think I heard that in a movie once). But, I believe in the will power of people. You business stumbles or struggles, then re-invent, adapt, overcome. Even if your business is flouishing, you should be looking for ways to innovate, to adapt, to overcome. I always think of IBM - IBM has been in business for more than 100 + years. But, the founders of that company in the 1880s would not recognize even one bit of what they company is now.

I agree that if you are scared about the future of your business to the point you won't take a chance on debt to grow (especially if the opportunities is staring you in the face) then 1) you should not take debt and 2) you should not be in business.

Vertexoneasset
11-23-2009, 12:11 AM
What is the meaning of debt? The meaning is- I have some plan to turn investment into profit, however, I lack initial funding. So I have to take a help. Now the important question is that how much debt should be taken. What parameters limit the extent of safe debt?

In this concern I would like to draw attention towards the prevailing market crisis that came into picture primarily because of uncontrolled debt management or say, mismanagement. Banks encouraged people to take debts to make life easy. Later on the asset value went so down that people preferred not to pay back as it did cost more than acquired loan.

When debt taken, it has to be fed into mind that some part of the profit has to saved so that if a business runs into unpredictable loss , you have some safe ground to stand and not let the boat sink down. I mean to say that you always have to make plans to keep some money aside other than profit and loss margin.

The balance sheet should have an entry that considers some deposited money as solely an investment. It is not a stagnant money rather an investment in crisis. I mean this saved money will be crucial in debt recovery.

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phanio
11-23-2009, 03:59 PM
Now the important question is that how much debt should be taken.

The amount that should be taken is the amount that is need right now - not what you think you will need later as you are taking too much.

One of the greatest manufacturing concepts that emerged in some time came out of Japan and was termed just-in-time manufacturing. This meant that businesses - in trying to keep inventory and stock costs down - developed a system where they would get raw material at the exact moment they needed them.

This could be the same in business financing. Get what you need when you need it - no more, no less.

It takes time and dedication to set up this type of system - but so does running the rest of your business.

Two things that really hurt new businesses - trying to get too much capital when they don't need it or waiting until it is too late to try to find funding.

If you can't reasonable assume (based on your research) to pay back a facility (regardless of what the market does) then you don't need the money or the opportunity is not worth taking on debt. But, there are always risk. If there was no risk - we would all be billionaires.

Vertexoneasset
12-29-2009, 08:26 PM
Yes just in time inventory management system has been one of popular method. However it is needed to clearly define safe and critical inventory stocks with respect to demand. Several statistical methods are necessary to calculate demands in advance.

LBFINANCIAL
01-25-2011, 11:48 AM
Debt is not always bad. I here a lot of what ifs about debt. I have a what if for you...... What if you never started your business where would you be?
What if you had to work 13 hours a day for someone else that refuse to let you get ahead? What if you were dependent on a check every 2 weeks and out the blue you go to work and the doors were chained? Debt in a business is only as bad as you make it. every business owner MUST take an assessment of his/her finances bills and possible gains and losses properly. If a company offers you a trade credit dont use the full limit unless you know beforhand that you can and will pay back according to terms. yes i know the only way to build good credit in business is to use it, but..... dont max out unless you have a iron clad plan on repayment. Try to program yourself that even if you are given time to pay, try paying in full each month. sometimes this is not possible, for instance if we offer a 500k loan to you and you use 350k of it, of course we dont expect a full payment in 30 days. in those type of cases, use a portion of the funds in good marketing and have an excelent business plan in play. very very important FOLLOW THAT PLAN.

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CloptonCapital
03-21-2011, 05:20 PM
There is definitely a difference between good debt and bad debt. Your example of a piece of machinery that is $120k that will double a 10k a month's business is obvious enough, but I would take it a step further. If taking on a debt helps save you money daily and you get to pay it off over the course of a decade, it is much better to have a 10-year debt for a good reason that a day to day loss for no reason.