Good debt vs Bad debt

Understanding the difference between good debt and bad debt

Managed well, debt can improve your credit rating, enable expansion, and stabilise cash flow. It’s the backbone of growth but with so many different types of borrowing now available, it’s important for your business to carry ‘good debt’ rather than ‘bad debt.’ 

Avoiding the high-cost finance associated with emergency funding keeps your business running smoothly. Good debt can provide lump sum cash injections or regular cash inputs that are planned and financially manageable over their term. 

So, how do you identify good debt and differentiate it from the bad debt that can lead to financial stress and even insolvency?

What is the difference between good debt and bad debt?

What is good debt?

Proactively planning your financial needs ahead of time and reliably sourcing the most suitable types of funding for the business is a key part of taking on good debt. It represents a positive step towards a specific goal.

You might need a new piece of equipment, for example, or additional staff to improve your output. Good debt includes loans with low interest rates or other beneficial terms that lower the cost of borrowing and help you manage the repayments without issue.

What is bad debt?

Bad debt is not debt that you take out. Instead it is a line of credit that you have extended to a customer or client which fails to be repaid.

While customers paying their invoices late is a relatively common occurrence in business, bad debt is a step beyond this. A debt is said to have turned ‘bad’ once a significant period of time has elapsed and a number of attempts have been made to recover the amount owed. Bad debt can also occur if the company that owes the money has become insolvent and has entered into a formal liquidation process and there are insufficient assets available to repay the money owed.

Once a debt is confirmed as being ‘bad’, this can be written off the sales ledger for accounting purposes.

How to source and manage good debt and avoid bad debt

A reliable business finance broker will help you narrow down your options but good debt management also relies on identifying the most suitable types of funding for your business. The whole-of-market approach we adopt at UK Business Finance ensures you access established and newer lenders as well as alternative finance products that offer the flexibility you need.

If you operate a strong sales ledger, for example, and would benefit from increased cash flow stability, we might determine that invoice finance is a good option. Hire purchase also represents good debt as it allows you to spread the cost of expensive assets and manage your budget effectively.

What if you already have bad debt?

We can offer advice on changing your finance facility to better suit your business – perhaps via loan consolidation or choosing a more flexible option, such as invoice finance. Not all funding relies on a good credit rating and with many new products on the market, it’s worthwhile establishing your best options for turning bad debt into good debt.

Our team at UK Business Finance will conduct a whole-of-market search to find the best deals on the market. We’re established commercial finance brokers and offer our service to clients free of charge.