What matters is what the debt is funding, not the fact that it exists
“Debt-free” gets treated as the gold standard of business health.
But a business that's never borrowed a dollar isn't automatically the healthiest one — sometimes it's simply the one that's grown as slowly as its own cash allowed.
The short answer
Debt itself isn't good or bad — what matters is what it's funding, whether the return genuinely exceeds its cost, and whether the business can comfortably service it. Debt used to fund growth, equipment or working capital that generates more value than the debt costs is a legitimate, often smart, tool. Debt used to cover ongoing losses or a fundamentally unprofitable operation is a warning sign, regardless of the interest rate.
The genuine test: what's the debt actually funding?
| Purpose | Generally a reasonable use of debt | Generally a warning sign |
|---|---|---|
| Equipment or asset purchase | Funds a productive asset that pays for itself over time | — |
| Growth-related working capital | Bridges the timing gap between sales growth and cash collection — a normal part of scaling | — |
| Covering ordinary operating losses | — | Suggests the underlying business isn't viable at its current scale, and debt is masking that, not fixing it |
| Paying existing debt or overdue tax | — | Often a sign of a deeper cash-flow problem needing real attention, not just refinancing |
Why debt-funded growth is often the sensible choice
Waiting to fund every piece of equipment or every stage of growth entirely from retained cash can mean growing far more slowly than the business's genuine opportunity allows — competitors move faster, market windows close, and cash sits idle rather than compounding. Debt, used deliberately for something that generates a clear return, is often the more efficient path, not a sign of weakness.
The genuine cost-benefit test
What does the debt cost? Interest and fees, expressed as a genuine annual percentage — not just the headline rate.
What does the debt enable? Additional revenue, cost savings, or capacity that wouldn't otherwise exist — estimated realistically, not optimistically.
Does the return meaningfully exceed the cost? If borrowing at 9% funds something projected to return 20%+ to the business, that's a potentially favourable spread — but a favourable spread on paper isn't proof the borrowing is genuinely sound. That depends on further questions: how reliable is the return estimate, what's the timing mismatch between when the debt is repaid and when the return actually arrives, how much does the outcome vary if things go worse than expected, what's the tax treatment, and can the business service the debt from its own cash flow even if the expected return is delayed or falls short? A wide spread makes the case worth examining seriously — it doesn't settle the question on its own.
Why the warning-sign category is different in character
Debt used to cover ordinary operating losses, or to pay off other existing debt, isn't funding growth or productivity — it's typically buying time against a problem that debt alone can't actually solve. This pattern, sometimes described as using debt to service debt, tends to compound rather than resolve, and is one of the clearer signals that the underlying issue needs direct attention, not just another loan.
A simple way to frame it
A useful question before taking on debt: “if this loan didn't exist, would the business be in a fundamentally better or worse position a year from now?” Debt funding genuine growth generally leaves the business better positioned. Debt covering an ongoing shortfall generally just delays a harder conversation the business eventually needs to have anyway.
A quick self-check
What specifically is this debt funding — growth and productivity, or an ongoing shortfall?
Have I honestly estimated the return this debt will generate, compared against its genuine cost?
Could the business comfortably service this debt through a slower period, not just its current trajectory?
If I'm borrowing to cover existing obligations, have I addressed why that shortfall exists in the first place?
When should you get professional help?
you're deciding whether a specific borrowing decision genuinely makes financial sense;
you're using debt to cover recurring shortfalls and want the underlying cause properly diagnosed;
you want a genuine cost-benefit comparison done before committing to a loan; or
you're managing multiple debts and want a clearer picture of your overall position.
Continue learning
→ Business Loan or Equipment Finance — How Do I Know Whether My Business Can Afford the Repayments?
→ Should I Use Business Cash or Borrow to Fund a Major Purchase?
→ Why Are My Sales Growing but My Cash Getting Tighter?
SKC Accounting | Knowledge Centre | Knowledge Guide 084
Last reviewed: August 2026
General information only. This guide does not take into account your individual circumstances and is not a substitute for professional accounting, taxation, legal or financial advice.