business advisor

When Debt Is A Good Thing

Don't confuse excess spending with wise business financing practices.

JERRY JERRY, O.D.

I'm sure you've heard the popular syndicated radio show in which listeners call in to proudly announce, “Hi, this is Sam Savemor, and I am debt free!” Dave Ramsey, the host, gives them a loud cha-ching and with great enthusiasm says, “That's wonderful! Tell me your story.”

A word to the wise

On this show, the clear inference is that debt is bad. I am well aware that consumer debt played a major role in the current U.S. financial crisis. But I don't want you, as a practice owner, to confuse excess consumer spending with the wise use of business financing.

An appropriate amount of long-term business debt can be a good thing when you're trying to manage your financial resources so you can grow your optometric practice. Take the following case as an example:

A sharp, young O.D. e-mailed me that she has been in practice a few years and just closed the books on 2009 with a gross income of $400,000 and a net of 35%, or $140,000. Her only long-term debt was a balance of $95,000 at a rate of 8% on a start-up loan. The payments are about $2,000 per month with no prepayment penalty.

“Dr. Hayes” she wrote, “I have worked hard to accumulate $100,000 in savings and am now anxious to get totally out of debt. Do you think I should take money out of my investment portfolio to pay off my loan or just keep making the payments?”

Keep your nest egg, or pay down your debt?

While I am sure Dave Ramsey would advise her to pay off the loan, Jerry Hayes says “NO!” My strong opinion is that this young doctor should not deplete her $100,000 savings to pay off the $95,000 loan at this stage of her career. Here are my reasons:

First off, paying down the debt would increase the free cash flow in her practice by $24,000 per year. But it would reduce her liquid net worth by $95,000. Ideally, young adults should maintain a cash cushion of six to twelve months income in the event of a major unplanned expense, such as an accident, illness or pregnancy.

However, the bigger reason for this young O.D. to keep her nest egg intact is that it gives her so much financial flexibility. You never know when a great investment opportunity, such as real estate or buying another practice, may present itself. She can move quickly if she has the cash in hand. It's a different story if she has to borrow money for a business deal.

Saving money is hard, spending is easy

By accumulating the $100,000 nest egg, she's already done the hard part. That $24,000 per year or, 6% of gross, is about the right amount for a $400,000 gross practice to spend on equipment. And remember, the interest you pay on business loans is totally tax deductible. So, her effective rate is really lower than 8%.

If you are still in the building phase of practice, don't let an appropriate amount of business debt bother you. It's ok to use other people's money, or OPM, to lease your equipment and grow your practice. That's what business financing is all about, and it's a very different thing from consumer debt. OM