Business

OPINION: Make debt a friend when creating business model

ESTABLISHING a profitable business model is obviously the key to any successful business. However, of equal importance is having a capital structure that matches it. By that I mean, having the right mix of debt and equity in your business.

Debt is a very valuable source of capital, because it:

  • Has a fixed return ("interest") which is lower than equity capital, thereby providing "leverage" by reducing the equity capital investors need to commit and improving their (positive) returns; and
  • Provides a tax deduction for interest, effectively discounting its cost.

However, debt also presents a risk because:

  • Unlike equity, which does not receive a guaranteed return, interest is a fixed cost which may not adjust in line with cash flow; and
  • Failure to honour debt obligations can lead to erosion of equity value and may result in bankruptcy.

Many people, whether it's buying a property or starting a business, will borrow as much debt as their broker can find for them for the acquisition, and then spend the ensuing months/years worrying about it until it is fully paid off. Because, of course, everyone's goal should be to be debt free, shouldn't it? Or should it?

Whether its your personal or business' balance sheet, debt is an important source of long term capital. However, due its characteristics, debt needs to be managed carefully and pro-actively.

Every household and business is different and the level of debt each is able to carry is also unique; depending on the volatility and predictability of its future cash flows. For instance, a construction company which has very lucrative but short term contracts, in a cyclical industry, should carry a smaller proportion of long term debt than a cleaning business with several 10 year government contracts.

While lenders may look at asset backing and alternative sources of cash flow (e.g guarantors) when determining how much they should lend, borrowers should base their decision entirely on the project's cash flows. At the early stages of a business, these cash flows are difficult to predict, so it pays to err on the side of caution.

As a business matures and its cash flows become more predictable, it may make sense to increase debt levels to release equity capital for other projects.

The type of debt is also important. Using long term debt for short term uses, and vice versa, can have disastrous consequences.

As far as possible, match your debt to its use. For instance, using credit lines or overdrafts for small, short term working capital needs can make sense if managed carefully. But don't kid yourself. If that working capital is really a long term liability, find another source of capital to fund it.

Regularly restructuring and refinancing debt, as part of capital budgeting, is what the CFOs of big business get paid six figure salaries to do because these companies see the enormous value in doing so.

* CAMPBELL KORFF is the principal of Yellow Brick Road Wealth Management, Northern Rivers.

Topics:  business debt money tax



Slaughterhouse nightmare: father's throat slashed with bull saw

Casino man Adam Paget needed critical transport to hospital by the Westpac Lifesaver Helicopter after cutting his throat with a butcher's saw.

'They didn't think he'd be able to talk, but he can, he just croaks'

Not good enough: our drink driving shame

New statistics paint a harrowing picture

The secret world of adult Lego fans

Adult fans of Lego have a huge community in Australia.

Lismore City Hall the backdrop for Lego fanatics for one more day.

Local Partners

Fresh calls for better broadband in regional Australia

'THE Government must take action to ensure that all Australians have access to reliable, high speed broadband': Medical association.


Celebrate our native Aussies on January 26

Davidsons plums are one of the foods native to our region. Made into a dipping sauce or marinade, they're perfect for an Australia Day barbecue. PHOTO: KATE O'NEILL

Spice up your Australia Day celebration with some local bush tucker

What's fresh at your local farmers' market

Chillies should be available at your local farmers' market. PHOTO: KATE O'NEILL

Chillies, figs, finger limes, eggplants are ripe for the eating

'More sick people will be jailed': Confusion over medical cannabis

There is ongoing confusion about the legalities surrounding medical cannabis.

Is it legal? Where can you get it? What are your rights?

Jennifer Aniston wants to return to TV

Jennifer Aniston is desperate to make a return to TV

Madonna hopes for election unity

Madonna hopes Donald Trump's election will "bring people together"

JK Rowling rules out Cursed Child trilogy

JK Rowling has ruled out a 'Cursed Child' movie trilogy

Buckley's chance in psychological thriller

James McAvoy and Betty Buckley in a scene from the movie Split.

Broadway veteran back on big screen with James McAvoy

Daniel MacPherson: acting’s a bit like channel surfing

Australian actor Daniel MacPherson in a scene from the American TV series APB.

THE Aussie export talks about making his mark in the US.

Shopping isn't fun if you can see dead people

Lisa Marie Woodham will be giving readings in Gladstone until Saturday January 21.

Shopping isn't fun if you can see dead people

Agents desperate for stock as homebuyers circle region

Coorabell houses had a whopping median sale price of $1.4 million.

Lower price ranges stand out as Coffs property best sellers

7 quirky Airbnb homes on the Northern Rivers

Broken Head Bodhi Treehouse

Stay in a shipping container or treehouse for your next holiday

Controversial Iron Gates development renamed

Raine and Horne

Peaceful, pristine and perfect is the new motto for Iron Gates

'That’s the nature of commercial reality': Lismore council

GAME CHANGER: The $13 million proposal by Quest proposal is for a three-storey complex featuring 41 serviced apartments, 53 on-site carparks, 24-hour on-site management, a gymnasium and modern guest facilities.

"It's a shame the development is no longer on the table"

Thousands of jobs part of $1b retirement village project

THIS YEAR: An artist impression of the new Aveo retirement village in Springfield.

Aveo Springfield unveiled this month, homes ready by July

Ready to SELL your property?

Post Your Ad Here!