How Much Debt Should Your Small Business Have?

Some amount of corporate debt is normal for nearly all businesses. Sometimes it's advantageous to carry certain debts even when the business may have the cash to cover it. But too much debt puts the company at risk.

So, how can you decide the right level of debt? And what can you do to manage business debt levels? Here are a few answers.

Why Manage - Not Eliminate - Debt
Not all debt is a bad thing. Credit allows a company to expand product lines, buy new equipment, and find the most advantageous locations. It can also cover cash flow failures or ensure that payroll can be made no matter how the business is doing. And low-interest debt is often an inexpensive way to fund projects. So your goal generally shouldn't be to eliminate all forms of debt.

However, you need good control so that debt doesn't become a burden. A company that over-leverages will risk losing assets it needs to continue operations. Too many debts take away from the financial condition of the business - potentially turning off lenders, bankers, and vendors who may extend more credit. And because debts must be paid each month, they can put pressure on cash during tight times.

How to Know If Your Debt Is Reasonable
If your business doesn't actively manage its use of debt, now is the time to start. You may need to analyze how much your debt costs the company overall - including fees, interest charges, and even lost opportunities to use the money spent on debt. Use this information to calculate your debt-to equity ratio - the amount of debt per dollar of owners' equity - and compare it with industry standards.

Then talk with lenders and banking professionals to find out how your debt profile appears to outside funding sources. And consider how much difficulty you have organizing and paying debt each cycle. A company with many small debts to different lenders - equipment loans, SBA loans, credit card charges carried over, lines of credit, and accounts payable - may work hard to juggle everything.  

What You Can Do About Debt
If you have any concerns about the company's use of debt, start by meeting with an accountant or business consultant. With experience in managing debt ratios, the accountant can help you target specific areas to control debt without harming the business. For instance, the accountant may help you consolidate small, high-interest loans or avoid anything that could damage your credit rating. 

You may also want to reorganize debt to take advantage of the right forms of debt and get rid of the wrong types. A line of credit used solely to smooth the cycle of cash flow when customers pay late, for example, is a useful but limited debt. If you keep that but work to ensure that all higher-interest credit cards are paid off each month, you have exchanged bad debt for good debt.

An accountant can also help if your debt-to-equity ratio is too low. A fear of business debt could hold you back from exploring ways to improve the business, such as by expansion or updating technology. With the guidance of a qualified accountant, you can craft a strategy to use limited debt to gain a larger return on your investment.

The sooner you craft a strategy for debt use, the better it will be for your company. Start by calling Williams & Associates Tax Services for an appointment. Our team of accounting and business professionals will work with you to create the right plan and execute it successfully so that your business stays healthy and thriving for years to come.