Debt Strategy: Good for Business Growth

How the use of debt can create a path for success

Bruce Bryen, CPA, CVA

The common thought process about taking on business debt is that if an investment purchase cannot pay for itself immediately then borrowing the money to pay for it is not a good idea. However, the astute businessperson understands the difference between good debt and bad debt. Going to a lender and requesting funds to buy or lease sophisticated equipment that increases productivity and brings more positive cash flow to the business, for example, is a smart decision. Let’s examine some examples of why the strategy of borrowing money makes sense and could be a business decision worth considering.

Debt for Profit and Growth

When a dentist contracts with a laboratory, he or she assumes that the finished product is one of quality with competitive pricing. For dentists, the preference of using one laboratory over another may then be determined by the service and speed with which that product is delivered to the dentist. The following is an example of how taking on debt to purchase a sophisticated piece of equipment with a price tag of $100,000 can work in the laboratory’s favor and achieve the service and speed preferences of its customers.

Based on the structure of the enterprise, such as an LLC, the laboratory can take a tax deduction of $100,000 in that tax year. Using the current year and borrowing the funds through the LLC, the laboratory receives a $100,000 tax deduction against its income for 2017. Of course, the lender will insist on a personal guarantee— as almost all lenders do when lending to small businesses with few owners and a thin capital base. If the laboratory owner can negotiate a loan over a 7-year term, the LLC will be paying about $1,500 per month including competitive interest rates. Assuming a tax rate of 50% including federal, state, Social Security, and Medicare (both halves for the owner), the owner saves $50,000 immediately in tax. At $1,500 per month for the debt servicing, the owner has the use of the tax savings of $50,000 on a declining basis of $1,500 per month for almost 2.5 years. In addition to the increased rate of production, speed of delivery, and tax savings, the laboratory owner will most likely have more satisfied customers because of the much quicker turnaround time provided. The owner will also enjoy savings because of reduced labor costs. Another consideration is that if the equipment is going to last more than 1 year, it should not be paid for in 1 year. If that happens, income suffers the year in which payment is made, and the period of time when the equipment is used has no offsetting expense to match against it.

Debt for Funding Retirement

So far, this discussion has centered on the use of debt to acquire equipment. However, debt can also be used to fund retirement benefits for the laboratory owner. A common occurrence at the end of the tax year is that the tax due has not been accounted for with proper planning. An economic approach to resolve this issue is to make a retirement plan contribution after the tax year has ended (December 31) and credit it to the previous year. This retirement plan contribution should be made prior to filing the tax return. An automatic extension of time will allow up to 6.5 additional months for paying the contribution and getting the retroactive deduction. This concept reduces the current tax liability and allows money to be saved for retirement without tax on its income until the funds are withdrawn.

Debt can create a substantial positive cash flow for laboratory owners and their businesses. When contemplating an equipment purchase, the implementation and funding of a retirement plan, or even a long or short-term lease, “good” debt is preferable to using operational funds that should be used for current overhead. The bottom line: Matching income with expenses that create that income is a profitable approach.

About the Author

Bruce Bryen, CPA, CVA, is the principal in the firm of RKG Tax and Business Services, LLC in Fort Washington, Pennsylvania.