February 28, 2013 Leave a comment
Remember the purpose of going into business is to build assets over time. George borrowed $5,000 to buy his lawnmower. On one hand he gained an asset worth $5,000 on the other hand he gained debt of $5,000. This debt appears on the liability section of George’s balance sheet. As George pays off this debt, his liability for the lawn mower decreases. George will also be using cash to pay off the debt which will reduce the amount of cash he has in his business. Simultaneously, George will use depreciation to reduce the value of the lawn mower asset on the balance sheet and reduce the profit in his business.
Word of wisdom about debt:
You should not be making payments on an asset that is no longer on your balance sheet. Your debt should not be used to finance your business i.e. used to pay for working capital. A business that consistently borrows money to meet its operating expenses will not be around for very long. Debt should be limited to capital expenditures with positive returns.