Why is debt supposed to be good?
I had an accounts program for my business once which would warn me, whenever I did a "health check" on the business, that my level of debt in comparison to capital was "below an acceptable ratio".
I did not take any action at that time, but have since noticed that the software company is now out of business.
Debt is not necessarily bad, but there does seem to have been an assumption leading up to the present crisis that companies should have debt to optimise their profits.
Now many of those businesses which had followed that trend are scurrying to replace debt with capital. I had four mailings from companies last week suggesting how I could benefit from buying additional shares in various lots from $500 to $10,000. They seem to have discovered that it takes only 100 small shareholders with $10,000 each to give them a million, 10,000 to give them a billion.
One even suggested that I might like to reinvest dividends in new shares -- something I used to do but which most companies had stopped offering, presumably feeling that all those little transactions were not worth bothering with when they could go out to world investment banks and funds to borrow.
I have to disappoint them. I started slowly converting from shares to cash around two years ago and am not planning to go back just yet. However, I am still reinvesting dividends with those companies where I have kept shares following the basic principle that Warren Buffett espoused of buying shares only if you'd want to buy the company if only you had enough money.
But what of the smaller business? Basic principles remain as they always have. If you can buy something and then sell it for more and cover the total of your costs, including your own living costs, then you have a good business.
Whether it is a market stall, an agency, a magazine, a newspaper or whatever, then a good business will survive. Some may have to adapt, but, for example, I continue to puzzle over why people will spend hundreds of dollars on a coffee maker for their own kitchen when for that they can buy hundreds of expertly made espressos and cappuccinos from friendly locals in their own high street. When families do not have the funds or security to go on an overseas holiday, they may well spend more on a coffee and cake and the occasional meal at a local bistro.
And a business which starts now, offering goods and services which people want, will be ready to show its expertise when the good times return. That is, provided the business does not borrow beyond its means. Debt is for use when money is needed short term, such as for a new commercial coffee machine which will immediately boost daily turnover, or for other equipment or even premises which will continue to have a value greater than the amount borrowed.
Just as a home mortgage remains a good debt provided you can meet the repayments and know that at worst you can sell up and have enough for the rental deposit on an alternative place to live, then debt is good for business if it is kept within similar bounds and you still make a profit after paying the interest charges.
I mention in one of my books the colleague who sold his car replacing it with a new one on lease in order to get cash back to buy a piece of equipment. And that was someone who had worked in the finance and banking industry... who obviously did not know the difference between good and bad debt.


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