Wednesday, January 13, 2010

Be Smart About Debt

One of the most critical elements of learning to manage your retail business’s financial situation is understanding the difference between smart debt and dumb debt. Understanding the wealth building or destroying power of debt could be the defining element of your future success.

Dumb Debt

This is the kind of debt you rack up from making impulsive purchases that you cannot afford. Dumb debt often comes as a result of trying to do what you would like vs. what is right for your business. It’s the kind of debt incurred from the instant gratification of making excessive and unnecessary purchases. It only sets you further back financially and does not help you build assets or reach your financial goals. An example is buying a lot of inventory from a designer whose style you love, without considering whether your customers have the same admiration for the designer and the potential implications to profits caused by excessive markdowns.

While much of dumb debt comes from credit card spending, not all credit card purchases are dumb debt. In fact, using a credit card can help your credit score, because you are building a favorable credit and payment history. But if you can’t manage your payments and you are strapped for cash each month trying to pay your credit card bill, you are going into dumb debt and you need to rethink your spending habits. Dumb debt can often lead to dumb strategies in order to service debt. Only use credit cards for your business if your sure cash flows will enable repayments!

Dumb debt does not just come from credit cards. You can also rack up dumb debt by buying too much inventory, investing in non-productive, expensive store improvements, being too generous with employee hours, benefits and pay, expensing too many “personal” expenses through the business, or underutilizing payables terms.

Borrowing money for any reason must be carefully weighed against the financial (not emotional) benefit of the debt to be incurred.

Smart Debt

Smart debt is the kind of debt that helps your business financially. If you get the right loan, utilize the proceeds to develop incremental business profits and manage your payments well, debt is a great tool to leverage and multiply profits. Low interest bank loans, lines of credit and supplier loans can be smart debt, provided they drive increment. Even credit card debt can be a smart decision, as long as you pay off your purchases in full each month. The greatest businesses in the world were built with the assistance and leverage provided by OPM (Other Peoples’ Money). Debt is a tremendous tool…..used wisely!

Knowing the difference between smart and dumb debt is important. Resist the urge of dumb debt so you can reach your financial goals with smart debt.

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