Imagine a successful business, thriving with growth and profitability. What comes to mind? Perhaps a strong leadership team, innovative products, or stable, increasing revenue. But what about debt? Contrary to popular belief, debt isn’t always a sign of financial struggle. When used strategically, it can be a powerful tool for accelerating growth, optimizing cash flow, and navigating economic uncertainties. This blog post will dive into the world of good and bad debt in the commercial contracting industry, providing insights and practical advice for subcontractors seeking to leverage debt to their advantage.
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Exploring Good Debt vs. Bad Debt
Before diving into the nuances of debt, it is crucial to establish one thing: We’re not advocating for reckless borrowing or suggesting that you should accumulate debt indiscriminately. Debt, when mismanaged, can be a burden, potentially leading to financial strain and instability. It is essential to approach debt with a strategic mindset, ensuring that any borrowing is done with thorough planning and a clear repayment strategy.
That said, the notion of avoiding debt entirely might also be a misstep. Many subcontractors view debt as a last resort, an option only to be considered when all other avenues are exhausted. This perspective, while conservative, may limit opportunities for growth and advancement.
When used strategically, debt can be a powerful tool in enhancing your business operations, managing cash flow, and fueling growth. Understanding the difference between good debt and bad debt can help you make informed decisions that contribute positively to your business’s financial health.
Good Debt
Good debt is borrowed money used strategically to contribute to your company’s growth and development. Good debt can come in the form of taking out loans or credit to invest in opportunities that will lead to increased revenue or operational efficiency. This might include financing equipment that allows you to transition from residential to commercial projects or materials for a new job. The key difference between good and bad debt lies in the purpose and planning behind the borrowing. Good debt alleviates strain on cash flow with a solid plan in place for repayment, including careful consideration of interest rates and terms.
Bad Debt
On the other hand, bad debt includes loans or credit that a company takes on without a feasible repayment plan, often resulting in accruing massive interest. Bad debt can trap a business in a cycle of repayment that drains resources and stifles growth. This type of debt may also come from predatory lenders who profit from poor financial decisions. Bad debt can drastically set a company back, leading to financial strain and potentially jeopardising its future.
We are strong advocates for the use of smart debt, not all debt. With this distinction in mind, let’s take a look at some of the most successful companies in the world and how debt has been integral to their success.
2 Large Companies That Benefit from Debt
Even the most successful companies use borrowed capital to accelerate their growth. From managing their initial costs to maintaining working capital, there are always reasons why a company might need access to additional sources of working capital. Here are three examples of companies that have effectively used debt to their advantage.
Uber
Uber, the rideshare giant valued at $66.6 billion, has openly embraced the strategic use of debt. Rather than turning to new investors—which would dilute existing shareholders’ equity—Uber chose to secure a $2 billion leveraged loan. This careful management of debt allowed Uber to achieve positive cash flow for the first time, showing that even companies with substantial debt loads can sustain strong financial performance.
Whole Foods
Whole Foods started with a borrowed sum of $10,000. When Amazon decided to acquire Whole Foods, they financed the purchase with debt rather than using their available cash reserves. Amazon borrowed money at low interest rates over a long period, which allowed them to maintain their cash reserves while still acquiring Whole Foods.
Leveraging Debt to Enhance Subcontract Closeout Procedures
Strategic debt management isn’t just about financing ongoing projects—it also plays a crucial role during the subcontract closeout process. When used wisely, debt can ensure that all financial obligations are met promptly, carving the path to a seamless project closeout. This proactive approach reduces the likelihood of disputes or penalties due to unmet obligations.
By understanding the implications of debt on the closeout process, subcontractors can use different sources of working capital to avoid last-minute financial stress and ensure a smooth transition at the end of each project. Effective debt management during this phase helps maintain strong relationships with general contractors and other stakeholders, ultimately contributing to your reputation and future business opportunities.
Using Debt to Support Business Growth
If you’re still hesitant about taking on debt, consider this: At an individual level, avoiding debt often makes sense because it’s associated with living beyond one’s means. However, business borrowing is different. Good debt, or leverage, allows you to use borrowed funds to grow your business and increase its value. By understanding the nuances of business debt, you can make informed decisions that support your company’s growth.
To strategically use debt in your business, start by meeting with your team to outline your growth initiatives, why they’re attainable, and how you plan to achieve them. Draft a budget that factors in expenses and cash flow to ensure you don’t take on debt you can’t afford. Consider using debt strategically for material purchases, pay applications, and even financing the closeout process to help manage cash flow efficiently. Understanding the importance of the closeout procedures is vital as well, as these procedures often impact your final payments and can influence how and when you decide to take on debt.
When evaluating upcoming projects, think about:
- How much material is needed
- The cost of that material
- The payment terms your supplier offers
- The timeline for receiving payment for the project
Since most pay applications take 60-90 days to process, many subcontractors face cash flow crunches when supplier invoices are due. Using material financing can help avoid this issue, allowing you to take advantage of cash discounts from suppliers while maintaining cash flow flexibility. For example, Billd offers a good debt solution for material financing, allowing you to purchase all your materials upfront with up to 120-day terms for payment.
By approaching debt strategically and using it to leverage growth opportunities, you can position your contracting business for long-term success.
Conclusion
In the world of commercial contracting, debt is often viewed with suspicion. However, when used strategically, it can be a powerful tool for driving growth, managing cash flow, and navigating economic challenges. By understanding the difference between good and bad debt and leveraging it responsibly, subcontractors can position their businesses for long-term success. So, don’t be afraid to embrace debt. With the right approach, it can be a valuable asset in your journey to a thriving and sustainable business.
