---

Episode Host: Henry Lopez is a serial entrepreneur, small business coach, and the host of The How of Business podcast show – dedicated to helping you start, run, grow and exit your small business.

---

Resources:

Related Podcast Episodes:

Episode 566: Good Debt Bad Debt

You can find other episodes of The How of Business podcast, the best podcast for small business, on our Archives page.

Transcript:

The following is a full transcript of this episode. This transcript was produced by an automated system and may contain some typos.

This transcript has been lightly edited for readability.

Henry Lopez [0:12]: Welcome to The How of Business podcast. This is Henry Lopez, and on this episode, I’ll share why waiting to save up the cash that you need to start or grow your small business could cost you far more than the interest on the right type of loan, and why leverage is a key to entrepreneurship.

You can find all of The How of Business resources, including the show notes page for this episode, and learn more about my one-on-one and group coaching programs at thehowofbusiness.com. I also invite you to join The How of Business community on Patreon, and please subscribe wherever you might be listening so you don’t miss any new episodes. And if you’re listening on Spotify, I invite you to answer the poll question for this episode.

Why Paying Cash for Everything Can Keep Your Business Small

Most of us have learned that we need to pay cash for everything and be debt-free, and of course, that’s great advice for your personal finances. But in business, it can be the very thing that keeps you small, and if you want to grow, you’re going to have to consider leveraging other people’s money.

We learned correctly, of course, from a mindset perspective, that consumer debt is bad: high interest, spent on things that lose value. That’s not a good idea. But then what happens is we tend to carry that philosophy or mindset into our thinking about how we borrow, or how we leverage cash, in our small business, and it can hold us back. It can hold us back from being properly funded to start a business, and perhaps more importantly, from being able to grow at the speed that you want to grow.

What Is an Asset?

Let me take just a moment to talk about what an asset is, at least by the practical definition of an asset. The simple test is that something is an asset if it generates income. I know that’s a cold, hard definition of an asset, but that’s the generally accepted definition. Now, your accountant is going to have a broader definition of that. I’m not talking about it from an accounting perspective.

The reason I make the point about defining an asset is that the rule is we should only borrow money to build assets or to buy assets, and a small business should be an asset. Of course, it needs to be generating a profit; it needs to be generating income. But if it does, or if it has the potential to, then borrowing to start or grow a profitable small business that brings in income is borrowing to build an asset. So that’s another way to think about why it is good to borrow for building assets.

Back on episode 566, which I called “Good Debt, Bad Debt,” I talked about this concept of what is good debt and what is bad debt, so some of this overlaps. If you want to learn more about this topic, I invite you to listen to episode 566 as well. But today on this episode, I want to go one level deeper into the why: a concept called the time value of money. I’m going to apply it in a certain way, so it’s not the pure definition of the time value of money, but how can we think of the time value of money to help us understand why leverage can be so powerful?

So I’m going to share this time value of money formula at a high level, from a business perspective, with a simple example, and I hope it’ll show you why putting all cash in, or waiting until you have the cash to grow, can be the worst return, even after interest on a loan. And I’ll share a quick way to check whether you have more room for debt and perhaps are under-leveraged.

The Mindset Shift: Personal Debt vs. Business Debt

But let’s talk a little bit more about the mindset shift, because I think it’s so critical, and I see this with a lot of my coaching clients and people that I talk to. I certainly struggled with this as well as I was becoming a business owner. Consumer debt in our personal finances is typically a bad thing, certainly high-interest consumer debt for things that are losing value. But good business debt, which we’ll talk about more here on this episode, is to invest in assets: your business in general, or expansion of the business, and ideally a business that generates profits. We should not be borrowing to keep a business afloat that has a broken business model, and I’ll come back to that point.

Bootstrapping is certainly a great way to get started, and most of us have no choice but to bootstrap. We have limited resources as small business owners, but at some point, it’s usually not enough to grow at the speed and level that you want to, and particularly to stay ahead of the competition. You’ll grow too slowly, and you’re going to miss opportunities. Now, this doesn’t apply, obviously, if you want to be a solopreneur or you are happy with where you are size-wise. This is for you if you want to grow your business to the next level.

Entrepreneurship: The Pursuit of Opportunity Beyond Resources Controlled

I mentioned the word entrepreneurship, and let me define that here. As I have chatted about before on this podcast, the terms entrepreneurship and business ownership are used interchangeably, but they really do have two different definitions. The definition of entrepreneurship that I prefer is from Harvard professor Howard Stevenson. Very simply, he defined entrepreneurship as, quote, “the pursuit of opportunity beyond resources controlled,” end quote.

There’s a lot in that short sentence: the pursuit of opportunity, business opportunity, beyond resources controlled, leveraging more than what we personally have. So by definition, entrepreneurs go after opportunities bigger than the cash that we have. That’s what leverage is: using other people’s money wisely to pursue an opportunity that you couldn’t pay for on your own with the cash that you have. Or, even if you have the cash, it still may not make sense to put your cash at risk, or to take it from something else where it might be making a good return.

So whether you’re starting a business or growing one, this is an important concept. When I say leveraging money, or other people’s money, it could be an SBA loan, it could be a conventional loan through a bank with a good rate, it could be a line of credit through a bank at a good market rate, it could be equipment financing, again at good rates, or it could be an investor or a partner that invests in the business. All of these are examples of reasonable-rate loans where you can comfortably cover the loan payments, or the debt service.

Now, what’s a reasonable interest rate? Well, as of the recording of this episode, with where interest rates are now in 2026, if you get a loan at 10% or so or under, maybe even up to 12%, that’s not bad. That’s good money. Certainly under 10% is great, and that’s right around where SBA loans are right now.

What We’re Not Talking About

On the other end of that spectrum, by comparison, are credit card interest rates, which have been at 23, 24%, the maximum that they can be, forever. That’s bad debt. So that’s not what we’re talking about. We’re not talking about carrying high balances on credit cards. We’re not talking about high-interest loans. We’re not talking about a lot of these short-term loans that get offered to us, the merchant advance offers, all of these types of offers that I’m sure you’re bombarded by, that either have front-loaded interest or really ridiculous interest and are really meant for very short-term emergencies. That’s not what I’m talking about here.

And again, coming back to the point about a broken business model: this is after you’ve gone through the startup phase. You’re a year into it, two years into it, three years into it, and your business is still not profitable, and you’re looking to borrow to keep a broken business model afloat. That is not what I’m talking about here, and not what I would suggest. I do not suggest that you borrow to sustain or keep alive a broken business model. And again, very simply, a broken business model is a business that is not consistently profitable after the startup period, and that does not have an opportunity to scale, either because of the complexity or because of how you operate the business.

So we don’t borrow for that. We don’t borrow to keep a business alive that really needs to be either shut down or pivoted.

Where I Disagree with the “Never Borrow” Advice

You know, there’s a lot out there, including from people like Dave Ramsey, the well-known personal financial advisor, but I think his advice as it relates to business is wrong. He says that you never borrow and that you run a business debt-free. You’re just not going to be able to scale to the level that makes sense for you, and as quickly as you want to. And if you calculate the return on investment, you’ll see the difference.

Where I do agree, though, as I said a moment ago, is never borrow to cover losses or pay for your lifestyle. Mike Michalowicz, the author of Profit First, makes this same point in that book: don’t use debt to hide the fact that a business isn’t profitable.

So I think that avoiding all debt usually means growing too slowly, and it means keeping your own cash tied up and at risk. There’s also an opportunity cost there. That’s money that you could have invested elsewhere. So use leverage, use borrowing at the right ratios to build assets, and that includes a profitable business. Again, at the right ratios, and use it as a tool. Borrowing money in business isn’t a sign of failure. Done right, it shows that you understand how money works and how we can leverage money, which is what entrepreneurs do.

A Quick Break: Your Free Coaching Consultation

This is Henry Lopez briefly pausing this episode to invite you to schedule a free coaching consultation with me. I welcome the opportunity to chat with you about your business plans and offer the guidance and accountability that we all need to achieve success. As an experienced small business owner myself, I understand the challenges you’re experiencing, and often it’s about helping you ask the right questions to help you make progress towards achieving your goals. Whether it’s getting started with your first business, or growing and maybe exiting your existing small business, I can help you get there. To find out more about my business coaching services and to schedule your free coaching consultation, please visit thehowofbusiness.com. Take that next step today towards finally realizing your business ownership dreams. I look forward to speaking with you soon.

The Time Value of Money

So let’s talk about this concept, or formula, of the time value of money. Many of you have probably heard of it before, but at its core, it’s simply that $1 today is worth more than $1 in the future. That’s because you can put $1 to work now by investing it or using it to generate revenue, and because of inflation, the value of the dollar lessens over time.

There is a simple formula for this, and I’ll put the formula on the show notes page for this episode at thehowofbusiness.com. But let me just walk you through an example. Let’s say you take $10,000 today and put it to work earning 8%, say in a mutual fund or in the stock market, making 8% a year. After one year, that grows to $10,800. After two years, it’s about $11,660, and you keep going with compounding. After five years, it’s about $14,700.

Now let’s flip it around, because that’s how I’m using the time value of money formula here to make the point about leveraging other people’s money. If someone promised you $10,000 five years from now, that’s worth only about $6,800 to you today, because you lose five years of putting it to work. Same $10,000. The difference is when you have it.

So what does this mean for borrowing? When you borrow, you get dollars today, and you put them to work by either building or growing an asset. You pay that money back over time, but those dollars are diluted over time because of the time value of money. Yes, you pay interest, and that offsets some of that. But if what you do with that money today earns more than the interest costs, then you come out ahead.

So borrowing is buying time. You bring future dollars into the present so they can start working for you now. And as we’ll see, the biggest cost isn’t interest. It’s waiting: the opportunity that you’re missing out on by waiting.

Cash-on-Cash Return: Paying All Cash vs. Financing

The other key concept here is cash-on-cash return. What is the return on the investment of my cash into this business, either to get it started or to grow it? That’s the most important thing to figure out to know if this is worth the risk: when am I getting that cash back, and what’s the return on that cash?

So let’s say, for example, you’re growing a business and you need a new piece of equipment or a service vehicle, or whatever the example might be for your type of business. Let’s say it costs $100,000, but that additional piece of equipment or vehicle generates about $30,000 a year in added profits. These are just simple numbers so that we can work through an example.

Option A is you pay all cash. You invest $100,000 in the business, or you take retained earnings, money that’s in the business that you’re using to bootstrap, and you invest that $100,000 in buying that vehicle or that piece of equipment. The cash-on-cash return formula there is the $30,000 a year return divided by $100,000, the cash that you invested in that asset. So that’s a 30% cash-on-cash return. Not bad.

Option B, though, is a different formula. What if we leverage somebody else’s money? What if we put down 20% in cash and borrow the other 80%? So again, it’s the same $100,000 expenditure or investment, putting $20,000 down in cash, either my cash or the cash that’s sitting in the business in retained earnings, and borrowing the $80,000. Let’s say it’s at 9% interest over five years. I worked it out, and the payment on that comes out to about $1,660 a month, or about $20,000 a year in principal and interest. So that’s the cost of borrowing that $80,000.

The profit after the full loan payment is, again, the $30,000 that this piece of equipment or vehicle is generating annually, minus the cost of borrowing, which is $20,000. That’s a net of $10,000 a year. Now, right off the bat, you’re thinking, “Okay, well, that’s a heck of a lot less than the $30,000 a year from the previous example, where it was all cash.” But hold on. We have to calculate cash-on-cash return, because now we didn’t put in $100,000 in cash. We put in $20,000 in cash. And despite the fact that our net return is now 10 grand after paying the debt service, the formula is $10,000, our net annual return, divided by $20,000, the actual cash that we put in, which equals a 50% cash-on-cash return.

If you remember, with all cash it was 30%. This is even after paying interest on that money, and you still have $80,000 of your own cash in reserves for the next opportunity, or for working capital, or to invest elsewhere. And if you extrapolate this over a number of years, you’ll see that the math still works out.

Trust me, this is something that you need to work out for yourself. Just take a spreadsheet and run the numbers. This is simple math, but I had to see it on a spreadsheet or on paper to really understand it, because it’s counterintuitive. At least it was to me. Not being a strong math person, I really had to walk through the numbers for it to make sense and for it to sink in.

Now, there is a trade-off, of course. The debt has to be in the right ratios, and that’s part of it. But you see how we calculated what the cost of debt is, and it still made sense relative to how much cash we put in, or invested, or tied up. And I understand that it’s certainly tricky to project how much income that asset is going to generate. But that’s what we have to do. That’s what we’re doing as business owners. You’d be doing the same kind of calculation if you were going to buy something or invest in it all in cash.

Your cash, of course, can then keep working. That is the point. So if we go back to that example, the $80,000 that I did not tie up in this asset and didn’t put into the business can now perhaps be invested elsewhere. Either it stays in my retirement accounts or equity in my home, or I put it into the stock market, or I wait for the next opportunity to come along, or I use it as working capital, or I use it to give me more leverage on inventory. There are lots of different ways that you can now use that cash, because remember, cash is king.

The Cost of Waiting

Now, we also have the time wasted, the cost of waiting, that comes into it as well. Because another option might be that you say, “I’m going to pay cash, but I’m going to save up until I have the cash later, so I’m not going to make this investment now. Even though it’ll grow my business, I’m going to wait until I’ve saved it up.” Let’s say you can set aside $20,000 a year. It’ll take you five years, and in five years you’ll have enough money to buy this asset.

But that’s five years without the $30,000 a year in profits, going back to the example I used of a $100,000 asset that generates about $30,000 a year in profit. So that’s roughly $150,000 over those five years that you never earned, just to avoid about $19,600 in interest if you had borrowed the money and paid on it over those same five years.

Why it works, again, is positive leverage. Borrowing at the right ratios, at the right interest rates, and for the right reasons, to invest in growth or in assets or to start a business, improves your return. But borrowing improves your return only when the investment earns more than the debt costs, of course, so you have to do that math.

Yes, it is counterintuitive, because paying cash feels cheaper, and there’s no interest. And of course, it’s what we’ve learned, and it does apply and make sense in our personal finance world. But when the investment has the potential to earn more than the interest rate, then the right debt at the right ratio gives you the better return on your cash investment, and therefore the better overall ROI.

Remember, again, I’ve repeated this several times, and I’ll probably repeat it again because it’s so critical: you do not want to borrow money to fix a business that isn’t profitable. I’m talking about after the normal startup stage. You’re only digging a deeper hole in that case, and that’s not what I’m talking about here.

How Much Debt Is the Right Amount?

So how much is the right amount? Debt capacity, working capital, all those things come into play. But generally speaking, there’s a formula called the debt service coverage ratio. Now, don’t let that scare you if you’re not familiar with it. It’s a simple formula. It calculates a ratio, a number, by taking your net operating income divided by your total annual debt service, your debt payments, and it gives you a number that can be used to compare. This is where you want to see: Am I borrowing too much money? Do I have too much debt, or do I have room or capacity to leverage more if it makes sense?

The target for that ratio is typically about 1.25, and that’s what a lot of lenders look for. Now, don’t worry about that too much right now. I’ll have the formula on the show notes page for this episode. Go and use it. I’ll have the checklist on this episode’s show notes page as well, so that’ll help you do the math, because that is critical.

There are two parts to this: understanding and making the mindset shift that borrowing is good in the right circumstances, but also making sure you don’t borrow too much and that you don’t drown in debt service.

Working Capital and the Risks of Borrowing

So borrowing money at the right rates and at the right ratios lets you take advantage of opportunities, because you can have some of that cash in working capital. Whether you borrowed it or you were properly funded one way or the other, it allows you to do things like take advantage of early payment discounts from suppliers, maybe volume or bulk purchase discounts from a supplier if that’s available, or say yes to a big order or a new client without scrambling for cash. Those are all reasons for having working capital, and it’s another reason to finance a long-term asset like your business, or a piece of equipment, or a vehicle, rather than paying cash for it. The cash you keep becomes your working capital.

Now, we’ve got to be clear-eyed, eyes wide open, about the risks of borrowing money. Those are there. Just to make sure we understand: with an SBA loan, for example, anybody who owns more than 20% of the business that’s borrowing is going to have to personally guarantee the loan. That means that even if the business fails, you’re still on the hook. And also, if you own a home, the SBA lender is going to want you to put your home up as collateral, so of course that increases the risk. So yes, it’s other people’s money, but it does become your risk, and that’s exactly why the math, the ratios, and the stress test are so important.

How to Get Started: Three Questions to Ask

So how do you get started before your next growth decision, or for that matter, before you start your business? Ask yourself this: Am I building an asset? Will this investment generate income, and does it earn more than the debt costs? If you’re covering your losses, fix the business model first. Don’t borrow to fix a broken business model. And of course, that doesn’t apply to the initial borrowing that you might do to start a business, based on calculations you’ve made and financial projections that show you have an opportunity to produce a profit that’ll cover the debt and give you a return. So, am I building an asset?

Question number two: What does waiting cost me? What is the opportunity cost? Compare the cash-on-cash return, all cash versus financing, and count the profit that I won’t earn while I save, while I’m waiting to have enough money in the bank. So understand this important concept of the opportunity cost, of not being able to take advantage of a situation or an opportunity when it presents itself.

And capacity: debt capacity. You’ve got to make sure that your debt-to-revenue ratio is right, and that you’re not going to drown in loan payments. It’s got to be at the right ratios, and that’s part of understanding where you are now. Do you have enough capacity to borrow, so that when the opportunity presents itself, you know that you have the capacity to do so?

Your CPA and your banker are going to help you here, and I can help you as a business coach as well. But make sure that you get guidance on this before you make a big borrowing decision.

On the show notes page, I will have the formulas that I’ve mentioned in this episode and the cash versus finance comparison, plus a link to the free Smart Business Borrowing Checklist that I mentioned. That’ll be on the show notes page for this episode at thehowofbusiness.com.

Wrapping Up

All right, let’s wrap it up. $1 today is worth more than $1 tomorrow, and smart borrowing lets you use tomorrow’s dollars today. The goal isn’t to avoid debt, but it isn’t to pile it on either. It’s the right debt, in the right amount, to build the right assets. You can’t save your way to growth. At some point, bootstrapping will not get you there. Leverage is key: the right debt, in the right amount, building the right assets.

This is Henry Lopez, and thanks for joining me for this episode of The How of Business. I wish you the best as you start and grow your successful and profitable small business. I release new episodes every Monday morning, and you can find the show anywhere you listen to podcasts, including The How of Business YouTube channel, and at my website, thehowofbusiness.com. Thanks for listening.