Positive debt? Is there such thing? I use this term frequently when speaking with individuals regarding debt. It’s more of a loose term to describe a perspective on how I see and view a debt. Let’s start first to what I would consider a negative debt. Simply put, any debt that does not increase asset value or generate positive cash flow is a negative debt. Your car, your boat, and that $10,000 European vacation is a negative debt. Hey.. I’m aware vacation typically leads to a better work/life balance and has been proven to boost higher productivity at work, but lets skip that for now. Chasing vacations can be expensive and create greater debts when we try to model an expected ROI and a turn key net monetization from investments.
Far too often I see business owners state “We want to operate debt free” Every time I hear this I just cringe with how such a lack of understanding around debt leverage these owners have. So often in our personal and business lives do we put too much focus in an area that distracts us from overall optimizing our best course of action. Our goal should always be to successfully navigate the allocation of our time and resources. To give example, think about when a company offers a consumer a product in exchange for collecting points. How after does the consumer rationalize and get distracted in their pursuit to get something “for free”. With the cost of time and effort not to mention the purchasing, couldn’t they have just bought the item outright? Same works with debt. Business owners can be too fundamental that debt is perceived as negative in their lives, as a constraint. Business debt’s design is to maximize financial leverage and function as a primary growth driver. Every major company strategically implores the use of debt for many forward growth initiatives — stock buybacks, R&D, acquisitions, expansion to other markets, etc. Companies can write off the debt interest payments.
Debt taken to buy frivolous purchases that serve a purpose for an impulse need or generates little or zero return on investment is typically how most people view debt. If we understand the primary function of debt leverage as another tool in an arsenal of a company’s assets we will see debt a lot differently. Simply said, debt needs to be used to maximize efficiency of working assets to increase overall enterprise value. This can be done to emulate secondary production and boost efficiency by deploying capital proceeds received from assuming debt to lower costs.
To understand this, we need to seriously consider the time value of money. This concept suggests that the money available at the present time is worth more than the identical sum in the future due to its potential earnings capacity. When we put this up to a model, we have to evaluate the best option to allocate cash on hand. This would be determined the value, over a given time, and return on assets generated from optimizing deployment of cash. That can achieved simply through investment, interest earned in money markets or bank accounts, or simply harbored as a buffer to provide a hedge of protection through a rough spot in an economic downturn. Dollars today are worth more than dollars tomorrow. The net present value of cash is determined by the value that may erode over time from inflation, etc. A company may choose to leverage debt in order to increase production by way of a new plant or location or invest in new technology. Theory would suggest that when strategically expanding in these directions, the economics of scale which lowers production costs makes a company more competitive and creates a moat, also know as a barrier to entry for other firms to enter their market space. Competitively speaking, the biggest and best companies understand this fundamental, and use it effectively to corral higher market share and remain on the forefront of competition. Simply put, companies that DO NOT view debt as a tool for growth and will have challenges against their competitors that do.
