Managing Your Business' Debt

A Balancing Act

Indeed, taking on the right amount of debt can mean the difference between a business struggling to survive and one that can respond nimbly to changing economic or market conditions.

A number of circumstances may justify acquiring debt. As a general rule, borrowing makes the most sense when you need to bolster cash flow or pay for growth or expansion. But while debt can provide the leverage you need to grow, too much debt can strangle your business. So the question is, how much debt is too much?

The answer, experts say, lies in a careful analysis of your cash flow as well as your industry. "A business that doesn't grow, dies," says Jerry Osteryoung, executive director of The Jim Moran Institute. "You've got to grow, but you've got to grow within the financial constraints of your business. What is the ideal capital structure a business needs in its industry to remain viable? The higher the volatility [in your industry], the less debt you should have. The smaller the volatility, the more debt you can afford."

Do Your Homework

To find out where your business stands, carefully examine your company's debt-to-equity ratio, which can help you keep debt within reasonable limits. The ratio is derived by looking at a company's long-term debt divided by its equity. Lower ratios typically indicate that the business is well within its borrowing capacity and can weather cyclical or seasonal downturns.

Bear in mind, however, that this benchmark can vary widely by industry. As a result, you will want to identify a debt-to-equity ratio specific to your business, which can reveal whether you need to pay down debt, postpone borrowing plans or even secure an investment to get your business on track. To get started, check out www.bizstats.com, which provides a useful online listing of average debt-to-equity ratios by industry.

Although banks and other financial institutions look for a satisfactory debt-to-equity ratio before agreeing to make a loan, don't assume a creditor's willingness to extend funds is evidence that your business is in a strong debt position. Some financial institutions are overzealous lenders, particularly when trying to lure or hold on to promising business customers. "I've seen cases where banks have [lent] way too much to a business," Osteryoung says.

Grant Lacerte, owner of Winter Haven, Fla.-based Financial Research Associates, agrees. "The bank may be looking more at collateral than whether the [business'] earnings are going to come in to justify the debt service," says Lacerte, whose company publishes small-business financial studies.