Leverage: When A Debt Makes Sense
Much has been touched on the issue of good debts and bad debts. In terms of consumption debt, once the money is spent, the loan still needs to be repaid.
This is for obvious reasons since banks typically charge the highest interest rates to credit cards and personal loans ranging from 12% – 24% p.a.
Debts incurred for loans like education loans however are considered good debt since there’s a good chance that the expected increase in income in future can cover the interest charged.
Singapore small business loans, if used prudently can also be a good debt for a company. Let’s take a very simple illustration on how a small business can take advantage of a business loan to generate higher growth.
Companies can borrow to capture demand upswings
Company A imports product X for $1 and sells it off for $2. Business is growing and it receives 10 orders for product X. However, it has only sufficient capital to fulfill 5 orders. Company A would then take a $5 loan from the Bank, which charges 10% interest for every dollar lend. Company A would still pocket a 90 cents profit per product after accounting for the interest charged by the bank.
This is just a simplified example on how companies leverage on financing loans to meet growth and demand, a popular concept also known as using OPM (other people’s money). The bottom line is: As long as the business can generate higher revenue/mark up than the interest charged by the bank, then a business loan would be considered a good debt.
Apart from fuelling revenue, business loans could also be used as a vehicle for tax reduction. The current corporate tax rate in Singapore is at 18% on chargeable income. The market rate for unsecured business loans is around 5%-10%.
The true cost of a debt is actually lower, because interest expense can be charged to the profit and loss account so that reduces the burden of a profitable company.
If you are a SME boss and perhaps there are a few shareholders in your company, it may not make sense to get Singapore housing loans in order to obtain capital if the other shareholders are not chipping in.