Getting out of debt is a good thing. Too much debt can cause a business to sink into desperate times. It should be a goal of every business or company to reduce its dependence on short and long term debt, and increase its assets. However, sometimes the decision to carry debt can be a good financial decision. The thing to consider is whether or not you will miss out no an opportunity to invest the money at a higher interest rate than the rate at which you borrowed the money. For example, if you borrow some money at a fixed annual percentage rate of six percent, and have the opportunity to invest some money at six and a half percent, then using the funds to pay off would lose you a half percent of net interest. That may not seem like very much in this example, but when we are talking about large sums of money, a business owner needs to look at everything he can to improve the financial performance of the business. As you can see, the interest earned cancels out the interest paid, and the extra half of a percent is profit.
As part of calculating the net benefit from this opportunity cost versus opportunity lost scenario, there are a few things to take into consideration. There are sometimes tax ramifications in paying debts and investing. This is also true in personal finance. For example, a loan such as a mortgage to pay for real estate has tax deductible interest. The tax savings on this loan makes the net interest rate lower than it would have been without the tax deduction. Also, money that you borrow to invest may have tax advantages also. Always consult your accountant, or whoever does the taxes for your business to make sure that you are legally able to take advantage of these tax benefits before making this decision.
It’s also important to make good investment decisions. It’s important to be able to access your investment money in case your debt needs to be paid off. It would be a shame if you lost your capital on a speculative or risky investment. The best thing to do is to invest the funds that you would have used to pay off a debt, or that you borrowed at a low interest rate for investment purposes, and invest it into a slightly higher interest rate. But make sure the investment is safe and has a fixed interest rate or varies only slightly. Make sure that it is insured, or guaranteed in some way in case of failure.
A great example of an organization that puts borrowed money, or money that is not their own to work, is your local bank. You may have a savings account where you earn two percent, and an automobile loan where you pay seven percent. The bank actually takes your money that is in your savings account and uses it to fund your auto loan. In fact, this is the whole principal behind what a bank does. Your business does not have to be a bank to put these principles into practice. You just need to learn how to leverage different rates of return, and make them work to your advantage.
By learning how to invest in low risk investments and borrow money at an even lower rate, you can cancel out the borrowed interest, and earn an easy, secure net profit.