Both options can be wise and move your enterprise forward. But business owners need to know which step to take, right now, before parting with precious cash.
The dilemma is ongoing for entrepreneurs: Should you invest in your business or pay off debt? Which is more important, and which should come first?
Investing in your business means you’re putting time and money toward things that will pay off later, like a new marketing strategy, new supplies, hiring an employee, taking a professional development course, or many more options.
While many of these investments sound appealing—and they may grow your organization and create significant ROI—it’s worth taking a look at your debt before spending on your business.
How do you decide where to start? Unfortunately, there’s no black-and-white answer. But when you weigh these pros and cons and assess the kinds of debt you have, you should be able to come up with the right answer for you, right now.
The benefits of investing in the business first
We’ve all heard the old adage: You have to spend money to make money. This line of thinking means that you have to give yourself the resources you need before your business will take off. Success doesn’t happen overnight, and you need to invest in the tools, technologies, equipment, and people.
Even if you’re short on cash and saddled by debt, the benefits of investing in your business first are:
- You can start earning more money now (for example, with a new business offering or by attracting leads through a new marketing vehicle)
- Freeing up time by hiring a new employee—allowing you to focus on strategy and growth
- Speeding up processes and operations by investing in a new tool or platform
Sometimes, entrepreneurs will initially forgo a salary and put that money toward business needs. While this isn’t possible for everyone, it’s one way that owners can invest in their business to give it the boost it really needs.
Just make sure that you’re not spending money you don’t have (e.g., using credit cards or dipping into earmarked funds) to grow. Undisciplined spending and resource management will make it far more challenging to balance cash flow properly.
The benefits of paying off debt first
Paying off debt is one of the best feelings in the world, whether you’re paying off business or personal loans. A weight is lifted, and you can start planning what to do with the money you’ve been paying to your debtor each month.
As an entrepreneur, you know how taxing it can be to continue to pay off the debts you’ve accrued. You may reach the point where you have enough money saved up to pay it off—but you’re unsure if it’s wise to give up the cash on hand, should an emergency or another unforeseen expense arise.
The key benefits of prioritizing debt pay-off:
- You’ll avoid paying interest that would continue accruing; depending on the terms of the loan, this recurring cost may be significant.
- Your credit score will improve, enabling you to acquire more capital for unforeseen expenses or expansion.
- You get rid of the huge liability that debt can be for a small business—a burden that ends many enterprises.
While all of these benefits may sound great, you still need to make sure this is the right way forward. For some businesses, cash is king—depending on where you are in the growth cycle.
Making the call: Invest or pay off debt?
First, consider the types of debt you have when deciding whether you should invest or pay off debt. Questions to ask yourself include:
- What kinds of debt do you have, such as revolving credit or long-term loans?
- How high are the interest rates?
- How much interest could you save by paying the debt off now?
- How manageable are your monthly payments?
For example, if you have a long-term equity loan leveraging a piece of property—the monthly payment is small, and the interest rate isn’t too high—it could be a smarter idea to invest in your business now and continue making the debt payments.
Also worth noting is that sometimes, you can defer or mitigate interest on your debt by acquiring a new loan, or simply lower it by renegotiating terms with a current lender.
If, however, you’re looking at short-term debt that has a very high interest rate, it’s probably smart to tackle that debt as soon as you can.
A good rule of thumb: compare the potential return of investing that money in a relatively conservative investment vehicle. If you have no hope of achieving better returns than your current interest, tackle the debt, and free up future capital. This same rule applies to the business: carefully analyze the potential ROI of a new investment, such as the tangible benefits of making a new hire. The closer you can nail down these numbers, the clearer a decision will be.
Finally, there is one rule that precedes making a new business investment or paying off any debt: always make sure that you have an emergency savings fund on hand in case you need it.
Provident CPA & Business Advisors specializes in helping small business owners minimize taxes, plan for the future, and take tangible steps that lead to growth. Contact us today to learn more.