Back in your school days, you likely had tests that included multiple-choice answers. And sometimes the difficulty of those questions was compounded when one of the answers was "all of the above."
That's the situation workshop participants encounter during an exercise I suggest.
Question: Your company is enjoying a banner year and you're looking to keep the momentum (and growth) going by buying a piece of equipment that costs $100,000. How do you finance the purchase?
A. The manufacturer offers a 2 percent discount if you pay upfront, so you pay $98,000 in cash.
B. The manufacturer offers 0 percent financing for 12 months, giving you a monthly payment of $8,333.
C. You obtain a five-year note with a 3 percent interest rate. Your monthly payment is $1,797 and there's no pre-payment penalty.
D. Any of the above options could work.
The correct answer here is D, although read on to see the preferred choice.
Most growing small- to mid-sized companies don't have piles of cash lying around, but if you're the exception, and can get the equipment at a discount and don't have to add debt, go for option A.
Meantime, if you have strong monthly cash flow and don't have a lot of debt to service, option B may be a great choice.
That said, it's likely that most companies are going to pick the third option.
Cash flow typically is a problem for our clients, so paying for equipment in bite-sized pieces tends to be the most-palatable option. A 3 percent interest rate is more than manageable, especially for clients that tell tales of interest rates topping 20 percent. And with no prepayment penalty, if you happen to somehow wind up with excess cash, you can always pay off the loan balance.
More often than not, we recommend option C to our clients, even those that are legitimately considering the first two options. The reason for that is flexibility, which means having more options.
Say you decide to pay for the equipment up front, using up a majority of your cash on hand. What happens if there's some kind of emergency that also requires a significant outlay? Or what happens if there's a situation when you need to spend money to make a much more significant amount of money?
All of a sudden, your options are limited and you may be forced to secure a much more expensive loan. The interest on that loan may negate the few thousand dollars you saved when you paid cash instead of took on a low-interest loan.
Too many entrepreneurs are scared to take on debt. While there's a general perception that debt is a bad thing - and too much debt certainly is - a reasonable amount of debt is a tool your business can use to grow and stretch your expectations.
Remember that if by assuming some debt it gives you a chance to increase your growth rate and cash flow, you may find yourself paying off that loan faster than you expect - opening up the possibility of using debt again to further improve your prospects. That's the happy exact opposite of a death spiral.