Understanding finance: how to use good debt

When talking about debt, it’s easy to see owing money as a bad thing. In fact, we’ve often referenced ‘bad debt’ as a receivable that a customer hasn’t paid and highlighted ways to protect against this. However, good debt exists.

Why is debt good for a company? And what is the difference between good and bad debt?

‘Good debt’ is a term used to describe any debt that can help generate future income or improve your credit profile. It’s planned and has a clear purpose and outcome. It can be used for anything: Expanding into new markets, investing in tools and technology, or even purchasing another business. Good debt usually comes with low interest rates and allows you to invest in your assets.

When you offer customers trade credit, they’re leveraging good debt to regularly buy your products or services and make consistent repayments, as agreed in your contract.

However, if you have extended credit and a customer is unable to pay or may not be able to in future, this is considered a bad debt expense as it reduces the accounts receivable on your company’s income statement and could cause a domino effect on the supply chain. After all, it only takes one break in the chain for a problem to arise.

If you’re curious about how good debt can benefit you or your business, take a look at the good debt examples below.

A commercial mortgage may be considered good debt as there is a transfer of ownership and a physical asset that you’ll partially own.

Making regular payments on a mortgage will build up equity and, although property prices don’t always increase quickly, they typically grow steadily over a long period of time. This equity can be released when you sell the property, helping you afford a bigger space, free up cash by downsizing, or this equity can become the collateral for a future secured loan.

If you use a commercial mortgage to purchase a property in the UK, the interest paid is also tax deductible. This means a business can deduct the interest from the company’s taxable profits and lower income taxes.
 

  Debt consolidation loans

Loans that help you amalgamate existing debt into one easy-to-manage monthly repayment may be classed as good debt .Although they may be spread over a long term, they could come with low interest rates and manageable monthly repayments. This will improve cash flow within your business, as well as free up time that could be spent on growing the company.
 

  Business loans

Low interest business loans are classified as good debt if they help you to start or grow a successful business. These funds can be used for numerous purposes including the purchase of stock, tools, machinery or technology, or even a business premises. However, this comes with risk and the debt can easily turn bad if the business doesn’t take off.

One of the most common types of good debt business loans is supplier credit.

This is when a commercial agreement is made for a business to purchase goods or services from a supplier, but payment is not made for days, weeks, or even months after the invoice is received.

There’s a risk with all debt and lending, and there is always the opportunity for good debt to go bad. So, it’s important not to lend or take on more debt than can be paid back.

With powerful business insights, our credit insurance services can help you make informed credit decisions and protect your business from bad debt. So, you can offer good debt terms with confidence that your receivables are protected.

If you’re ready to grow your business safely by offering protected credit to new and existing customers, Allianz Trade could be your perfect partner.

We monitor over 83 million companies worldwide with 1,700 credit analysts based in 62 countries to assess businesses and to indemnify the value of goods or services you have delivered should a customer default on payment.

Find out more about our market-leading trade credit insurance online today.