Activity 8b: Current versus capital spending and bad versus good debt
- Current expenditure includes refers to spending that are necessary and mostly re-occur every year in order to keep an entity running (e.g. cleaning expenses or wages) whereas capital expenditure irregular payments for items or assets that provide benefits for an entity into the future (e.g. capital equipment).
- Household A needs to borrow $10,000 and Household B needs to borrow $40,000.
- This because Household A’s $10,000 debt is used to fund recurring expenditure whereas Household’s B $40,000 debt is used to fund ‘one off’ expenditure that actually has the ability to contribute to future income generation (unlike Household A’s debt). So Household A’s $10,000 debt, despite being smaller by $30,000 is bad because it has the potential to increase pressure or strain on Household A’s future budget position (relative to Household B whose future budgets should be enhanced by more income).
- Household B’s debt is ‘good debt’ in so far as it is used in a productive way – such that it contributes to future income for the household and therefore increases the likelihood of future surpluses rather than deficits.
- This is because the $40,000 capital investment in the motor vehicle/business is deducted from the $140,000 in cash expenditure to arrive at an operating expenditure figure of $100,000.
- If the same income and spending patterns were to continue into the future, then Household A’s current budget position is unsustainable because it would struggle to service its growing stockpile of debt.
- Household A should simply attempt to reduce certain types of expenditures (e.g. cut down on non-essential/luxury items) and/or find way of generating more income (e.g. increase hours of work or engage in some business activity).