In many cultures across Southeast Asia, it is common for debt to be thought of as a taboo. A common assumption made is that only people who spend irresponsibly take on debt. Traditional businesses owners, similarly strive for a debt-free business. However, there are many reasons why taking on loans are necessary. It is good to note that there are times that debt can be seen as a positive indicator that a business is doing well.
When is debt necessary?
According to DP Information Group’s SME Development Survey of 2017, SMEs often face finance related issues such as delayed payments from customers and tightening of credit access by their suppliers. In order for these businesses to ensure they can continue to operate, a business financing solution such as invoice financing and business term loan may be necessary.
This does not mean that the business is irresponsible or failed to formulate a sound business plan. It is common that these situations are caused by unforeseen situations such as a delay in shipment due to bad weather. Businesses should take this opportunity to learn from these situations and make better financial projections in the future.
When is debt seen as a positive indicator to a business?
Looking from a business planning perspective, businesses may take on loans to grow their business. It may be a case where the business needs to expand quickly to capture more markets and larger market share. Additional funds from a loan can accelerate the growth of a company. Businesses will now have the funds to improve various aspect of their business, such as purchasing more equipment, opening a new store, hiring more staff, etc.
From the standpoint of a lender, if a business has existing debt, it shows that the business is credit-worthy and the other lender is confident that the business is able to repay the loan.
Businesses may need funds for new projects, such as entry to a new market or opening of a new store in another location. Businesses may choose to undertake large projects after evaluating their projects with tools like Net Present Value (NPV) and Internal Rate of Return (IRR). Both of these tools help to measure the viability of the project and help the business owner determine whether the business opportunity outweighs the cost of debt.
To take on new projects, businesses can fund the project with internal funds, debt or equity. Most often, for large scale projects such as business expansion, internal funds may not be sufficient. For many SMEs, business owners will not fund their business with equity as it relinquishes their ownership of their own business. Therefore, debt financing is the most viable option for many SMEs.
In conclusion, businesses should carefully evaluate their cash flow and working capital needs before taking on a debt. By making financial projections prior undertaking new projects, businesses should not be afraid to take on debt as long as they have confidence in their calculations. When the funds from a loan is used with the right intent and not used for other purposes, debt can be a positive indicator that a business is growing.
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