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Debt. It’s the word many small business owners hate to hear. It’s a reality for most businesses however to incur debt to finance operations, at least in the start up years. Although many small businesses are denied credit in the first few years, others have bankers and credit card companies begging for their business, especially those companies whose owners have substantial personal assets to attach.

I hear the following from small business owners every day:

“It doesn’t matter. I get to write it off.”

“You can’t operate in this industry without a big line of credit.”

“I need a corporate credit card to take my customers out to lunch.”

“You have to spend money to make money.”

All of these arguments are quite superficial and speak more to our penchant for overspending than anything else.

The first statement, “It’s a write off...” is the most tenacious argument of the lot. Many small business owners think that because something is tax-deductible, it’s free. If you look at it on paper, however, you will see the foolishness of the premise. Let’s say, for example, that you spent $1,000 in interest on a loan. The $1,000 is certainly deductible from your income. At a 25% corporate tax rate, this would give you $250 in tax savings. But you still had to fork over $1,000! You are still out of pocket by the difference, or $750.

It’s critical to get a grip on your debt picture and how much interest you are paying. This will help you plan and grow more effectively in the future.

Understanding Debt Service

Debt service represents the amount of money it costs a business to maintain or “service” its debt. It includes both interest and principal payments required for a company to remain on-side with its lenders’ covenants or agreements.

Some of your debt may require interest-only payments while some might be a blend of interest and principal repayments.

The purpose of incurring debt in any business (both the corner store and General Motors) is to generate more revenue. This is called leverage. The theory is that with more capital available to a business, it can buy more equipment or invest in more promotional activities in order to bring more customers in the door. In many cases however, a lack of understanding of these principles hides the fact that debt is simply being used to prolong the agony of an unprofitable business. Understanding your total debt service will help you to determine whether your indebtedness is helping you earn revenues.

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Written by: Angie Mohr
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