Reduce Debt or Increase Savings

A lively debate broke out at the office regarding whether it is better to save or better to pay down debt. While the conversation in the office was in regard to personal finances, much of what was said has implications to businesses as well.

A business generally runs a budget that balances both short-term and long-term needs. Every month, money comes in from certain sources, expenses have to be paid, and debt, if any, needs to be managed. In the long-term, money might be needed for acquiring new equipment, or to make a hire. Additionally, some months might have lower than usual revenue, so funds may be needed to cover for that eventuality. Last, there may be some long-term expansion goals that will require significant amounts of money, which will have to be drawn either against debt or against savings.

Of course, there is also the issue of taxation. Depending on the sums involved, the taxes on any unused funds may be quite high, and there may be certain advantageous ways to make use of that money to reduce the tax load. In some cases, spending the money to reduce debt may carry certain advantages, in other cases, investing the money may be better, and in some cases, declaring a dividend to the owners of the company may be the route to take.

However, the thought process that goes into saving over debt-reduction in business is not quite the same as for a personal investor. While a personal investor needs to deal with feelings, since their personal equity is being placed on the line, businesses are concerned with absolute results. The potential savings or costs of each route can be determined with a high degree of certainty, and the eventual needs of the business can likewise be measured. What cannot be measured is the potential returns of a given investment, but that question can be made irrelevant by the savings in other sectors (such as taxation).

Should your business save, or reduce debt? It’s not all about the numbers.

That’s not exactly right – ultimately, any question asked to help settle this decision will involve numbers, more so, perhaps, than with personal investment strategies. However, many of the questions will also involve goals – do you anticipate a need for the money in the near future, or do you see the business rolling along without it for years to come? How much money will you need when it comes time to make certain purchases? If you will need to borrow those sums anyhow, then perhaps an investment strategy is not relevant.

How would you decide? The interest rates alone won’t help you, nor will the tax implications. What you need is a financial advisor who understands not just these two factors, but also the nature of your business and your industry. This creates yet another position on your dream board of directors – a financial advisor who is concerned with more than just budgets, but also with long-term financial planning.