This year has been a challenging year especially for small businesses. Some businesses may be struggling on deciding if they need to take out a business loan to keep things above water. This reminded me of a joke I heard the other day… I recently met a friend of mine while on an afternoon walk. “Hey there George, why do you look so down today?” “Kevin, man, I’m in trouble. I need money for my business, and I have absolutely no idea where to get it from!” “Oh, I’m sure glad to hear that” I said. “I was afraid you might ask to borrow it from me!”
Jokes aside, having access to business capital can be crucial to your company’s success. Natural disasters (like the current global health crisis), market changes, new product development and countless other risks, challenges, and opportunities all scream for working capital. There is a tremendous amount to unpack in this topic, but here we will cover some of my opinions on the concept of debt-free vs. leverage and how you can use working capital to do what you do best. You can also view one of our latest blog posts here for recession-proof business planning.
What is financial peace?
Dave Ramsey’s financial model outlined in his New York Times best-selling book “Financial Peace” illustrates the psychological solutions to staying out of debt. Mr. Ramsey, in my opinion, correctly hits the proverbial nail on the head regarding many people’s view on borrowing money, in this case, a business loan. The world these days tells you that you can afford anything if you can just make the monthly payments. Many people want what they want, and the lenders tell them they can afford it, so they buy it on credit. Financial Peace provides the psychological solution that many people need to make the right decisions. He teaches the zero debt, pay-off your lowest loan amount first approach. This helps folks who see their mountain of debt, such as a house, couple of cars, student loans and credit cards, as something that can eventually be conquered. And he is right, it can!
Financial Peace purposes that no debt is good debt. While I see an enormous amount of value in this psychological solution for what is essentially a mathematical problem, some are able to see above that and into what it can be easily boiled down to. Pluses and minuses. In your business you likely deal with pluses and minuses every day. So, let’s assume you can see beyond the psychological barriers of debt weighing you down and you’re able to use borrowed funds to earn you more than the interest you pay. Leverage, when respected, can truly be a beautiful thing!
Assets vs. Liabilities
Now let’s use a counter point to Financial Peace. Robert Kiyosaki’s “Rich Dad Poor Dad”, also a New York Times best-seller, essentially takes an opposite view on debt. Rich Dad Poor Dad explains the true value of your money earning you more money, teaching that the rich get richer because of this concept.
This can be applied to our topic, and specifically to you since it takes working capital for you to produce your product or service in your business. In his book, Mr. Kiyosaki instructs that you can either purchase assets, or liabilities. Assets earn you money while liabilities cost you money. In your case, you and your business are the asset. The more you invest, the more opportunity you have to grow.
Both books make fantastic points and really help to grow the reader’s understanding of fundamental financial concepts. I would highly recommend them to readers of any financial background. For me, it was crucial to get both sides of that “debt-free vs leverage” argument before I truly understood either. It can be very easy to get caught up in one or the other and quickly desire radical change, but by consuming both I was able to find what I call the healthy middle.
How Do I Know If I Need a Business Loan?
Ultimately, as the decision maker in your business, it’s up to you to know your numbers. Will a business loan net you the return on investment to exceed the interest costs? Or, are you knowingly borrowing funds that you think will help you solve an immediate need, but cost you more in the long run?
While one may be superior to the other, both are viable reasons for taking out a business loan. I only encourage that you make that decision knowingly, and with as much data as you can collect. I also urge you not to fall into the psychological pitfalls of solving math-based problems with emotional reasoning. Don’t listen to the world saying, “you can afford it”. You very well may be able to, but you should come to that conclusion yourself or with the help of a financial professional.
Debt is a regular, and often essential tool in building a successful business. Leveraging the capital you have access to, at the right time, and increasing your ability to consistently produce your product or service, can be the best business decision you’ll ever make.
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Tax Advisory Manager