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Business Loans: Respect Debt But Never Be Afraid Of It



New Member
Staff member
In a perfect world every business would throw out large amounts of free cash flow which could be used to expand and build on an ongoing basis. In reality this rarely happens and sometimes when opportunities arise business loans may be the perfect way to finance growth. Many people are scared of debt, frightened to take that chance and more inclined to build up a war chest over the years and wait. We are not suggesting unresearched investment, ramping up debt for the sake of it or jumping into areas of business in which you have no experience or skills, but simply utilising debt to expand your existing business.

If for example you were to take out a £10,000 loan over a three-year period with a fixed interest rate of 12.9% you would be paying circa £350 a month towards capital repayments and interest payments. If you were able to use the £10,000 loan to acquire an asset which brought in a net income of for example £700 a month then you would have an excess of £350 a month over and above the finance costs. This could be used to pay down the loan at a quicker rate or even utilised elsewhere in the business to grow and expand. If you were able to improve the business/asset in question then you have the potential to increase the £700 a month net income and create an even better return on the original £10,000 loan.

On the other hand, if the asset you were acquiring was not income producing or was producing less than the £350 a month loan repayments, this adds pressure to your business. You would need to find the additional repayment funds from elsewhere and even if you able to improve income from the asset you acquired this may take some time and nothing is guaranteed.

The first situation is a no-brainer, the asset acquired brings in more money than the cost of finance (with some headroom). The second situation is not as clear cut because even if you were able to increase the income it may take some time and may not necessarily reach the £350 a month breakeven on the loan payments.

In reality there would have to be a return above and beyond finance costs to make a debt funded acquisition attractive for any business. There is an argument that even a breakeven scenario when taking into account finance costs would leave you with an asset which was valued at £10,000 once the loan had been repaid. However, very few business people would invest for no return so in reality the income created by a debt funded asset acquisition would need to be significantly more than the cost of finance.

In business it is essential that you respect debt but never be afraid of it. Used correctly it can speed up expansion of any business, allow you to take advantage of special situations and the greater the return above and beyond the cost of finance, the more attractive it becomes.