[This is part of the series: 7 Tips To Make You Better At Business]
Businesses and the senior managers that run them need to treat debt as a path to be avoided.
In favor of debt, you will hear professors and analysts argue about internal rates of return.
This idea is best seen in a simple example.
What if I have a business, or project within a business, that can earn 10% per year on an investment.
If the cost of borrowing in the same example is (say) 6% per year – then one would say that this is considered “good debt.”
A 4% annual return can be earned through this debt and corresponding investment.
The problem is that this is not entirely true.
What is actually true is:
“A 4% annual return can be earned through this debt and corresponding investment – assuming nothing else changes.”
What if inflation ticks up?
What if technology changes your business or project?
What if a major customer leaves?
What if your largest salesman leaves for a competitor?For this same reason, people make the same mistake with debt in their personal lives.
“I can afford debt for a big house, a nice car, extravagant vacations, whatever.”
Yes – you can afford it – now – assuming you never get a pay-cut, you never lose your job, or you never have any large and unforeseen expenses. Otherwise, you are going to be like the others I have seen that trade in their car and sell their house at the first major hiccup with household income or expenses.
How many of us live paycheck to paycheck?
How many businesses are essentially doing the same?
I have told a story before about a small company that had around $30,000 in monthly debt payments after a major project fell through. Income from the project went to zero – but the debt was still there.
The debt is now sinking the company.
You want to expand your business or buy something new? Pay for it out of your pocket.
- Debt restricts you.
- Debt obligates you.
- Debt ties you down.
- Debt makes you beholden to another.