Pinpoint what level of debt is healthy for your business to execute your strategies for growth, whilst not letting your debts get on top of you.
Managing debt for any business is a precise balancing act. Across industries, borrowing opens the door to business expansion that would not be achievable otherwise, but on the other hand, the accrued debt could easily become a looming threat if the company does not grow as much as its directors anticipated, which could ultimately limit its operational flexibility and give way to financial issues. As such, it is pivotal to pinpoint what level of debt is healthy for your business, such that you can execute your strategies for sustainable growth and development whilst not letting your debts get on top of you.
How to determine a healthy level of debt:
Debt-to-equity ratios are used to establish a healthy level of debt according to different business’ circumstances, indicating the extent to which a company relies on borrowing in comparison to the value of its capital. Although a debt ratio of 1% or less is generally considered an indication of stability and operational flexibility, whether or not higher levels of debt could still be classed as healthy will vary depending on factors such as your business model, the industry within which you operate and profitability levels. As a result, although a debt-to-equity ratio of above 1% may seem unhealthy on the surface, it may not be deemed as such if this additional debt can be justified in terms of the company’s predicted growth and long-term returns. Although this varies on a case-by-case basis, it is important to consider such things as whether taking on additional debt is necessary to keep up with your competitors and how your debt-to-equity ratio compares to other companies in your industry.
Factors that might affect the stability of businesses with debt:
- New competitors – Although looking at a business’ current competitors can be useful when identifying a healthy level of debt, the establishment of new competitors is difficult to foresee and could have an effect on your company’s plans for expansion, thus offsetting your debt levels to your equity.
- Market decline – A downturn in your market, or even wider spread financial issues like recession, could occur unpredictably and hamper the growth you anticipated for your company.
- Interest rates – The possibility of inflation and a rise in interest rates could limit your business’ ability to service its debt.
- Legislation – The passing of new laws that could potentially impede the expansion you envisioned for your company could come in many forms, such as changes to minimum and living waves or workplace pension duties.
- Personal guarantees – If you have provided personal guarantees for any of your business’ borrowing, you could find yourself personally liable for the company’s debts should it decline and not be in a position to make its repayments.
Receive a Free Financial Health Check
If you would like to receive a financial health check for your business, you can do so for free on our website, and it only takes five minutes.
If you would like further advice on establishing a healthy debt-to-equity ratio for your business and whether or not you could be at risk of being held personally liable as its director, contact Voscap today at 020 7769 6831 or email team@voscap.co.uk to speak to one of our business recovery specialists.
