Debt: Good Debt vs Bad Debt for Entrepreneurs

Not all debt is created equal. For entrepreneurs, the difference between good debt and bad debt comes down to one question: Will this borrowing generate more value than it costs? Good debt is a strategic tool that fuels growth. Bad debt is a financial drain that erodes cash flow and limits options.

What makes debt “good” or “bad”?

Good debt is borrowed capital used to acquire assets or resources expected to return more than their total cost (principal + interest + fees). In other words, it’s an investment in future cash flow that increases your business’s net worth or earning capacity.

Bad debt is borrowed capital used to fund consumption, cover recurring losses, or purchase depreciating assets that won’t generate revenue. It depletes existing cash flows without creating lasting value.

The key differentiator is return on investment (ROI). If the expected return exceeds the cost of borrowing, the debt can be considered “good.” If not, it’s likely “bad.”

Examples of good debt for entrepreneurs

Good debt typically finances growth-oriented activities with clear ROI potential:

• Equipment or machinery that increases production capacity to meet growing demand
• Business expansion such as opening a new location or entering a new market
• Inventory purchases for proven, high-turnover products
• Research and development (R&D) for new products or services
• Hiring key staff that directly contributes to revenue generation
• Marketing campaigns with measurable customer acquisition costs and lifetime value
• Technology or software that improves efficiency and reduces long-term operational costs
• Commercial real estate in locations with appreciation potential

Good debt also tends to come with favorable terms: low or reasonable interest rates, manageable payment schedules, minimal origination fees, and no annual charges.

Examples of bad debt for entrepreneurs

Bad debt often results from reactive, unplanned borrowing to cover shortfalls or fund non-essential expenses:

• High-interest credit cards used for routine operational expenses
• Payday loans or merchant cash advances with exorbitant effective interest rates
• Luxury or non-essential purchases that don’t contribute to revenue
• Covering recurring losses instead of addressing underlying business model issues
• Depreciating assets like vehicles or equipment that lose value faster than they generate income
• Unplanned emergency borrowing due to poor cash flow management

Warning signs of bad debt include high interest rates, expensive origination fees, unmanageable installment payments, and payoff terms that are difficult or impossible to meet.

How to evaluate debt before borrowing

Before taking on any debt, ask yourself these questions:

1. What is the ROI? Will this expense generate more revenue than the total cost of the debt (including interest and fees)?

2. Is this proactive or reactive? Are you borrowing to seize an opportunity, or to cover a shortfall?

3. What are the terms? Are interest rates reasonable? Are payments manageable within your cash flow?

4. Does it increase net worth? Will this purchase add lasting value to your business, or will it be consumed/depreciate quickly?

5. What’s your debt-service coverage ratio (DSCR)? Divide your net operating income by total debt service (principal + interest). A DSCR above 1.25 is generally considered healthy.

Practical guidelines for Philippine entrepreneurs

For small and medium business owners in the Philippines, consider these additional factors:

Compare lending options carefully. Government-sponsored programs (like DTI or SBC loans) often offer lower rates than commercial banks or online lenders.

Keep liabilities below 20–36% of assets or income. Most experts recommend a debt-to-income ratio under 36% for personal finances. Apply similar discipline to business borrowing.

Build credit strategically. Consistently repaying good debt on time improves your business credit score, unlocking better terms for future borrowing.

Avoid using debt to fund lifestyle. Separate personal and business finances to prevent blurring the line between growth investment and consumption.

Debt is a tool, not inherently good or bad. Used strategically, good debt accelerates growth by funding assets and opportunities that pay for themselves. Used carelessly, bad debt becomes a burden that drains cash flow and limits your options.

The best debt is one that has been repaid and that leaves your business stronger than before.