Managing debt in your business can be very difficult.  It’s stressful and can bury a business very quickly if its not managed properly.  Often times businesses must take on debt to start, maintain or grow their operation.   Taking on too much debt can crush a business.  Paying cash for capital expenditures can drain the business of cash reserves needed to operate the business in the future. Balancing debt load and cash reserves is critical to long term business success.  Knowing your debt load as a percentage to gross revenue, gross profit, and net income is extremely important.  Too many times debt service is not taken into account as it is calculated after net operating income.  If your net operating income is $50,000 and your annual debt load is $30,000 then your cash at the end of the year after debt service is $20,000.  Your business can be showing a healthy net operating income but could be drowning in debt which is eating up all the cash from the net operating income.

Knowing the percentage of debt to gross revenue is very important.  This allows you to be able to understand how much debt you can sustain depending on the gross revenue the business is generating.  For example, if you set your PNL budget to operate on a 5% debt load then you know for every $100,000 in annual gross revenue your business can sustain $5,000 of debt payments annually.  Knowing this threshold is critical.   Every business is unique.  Different businesses can operate at different debt loads.  The key is finding the debt load that fits your business and driving capital expenditures and debt based on this threshold.

The higher your debt load the less cash your business has to pay for expenses.  If your debt load climbs to 10% or above you can starve your business of cash to pay expenses.  When buying new equipment for your business you can use this test to figure out if the purchase will fit in line with your debt load.

For example, if you are going to grow your business and add a new mowing crew you will need to add a truck, trailer and mowing equipment.   You estimate that this 3 man crew can generate $125,000 in gross revenue per season.  You also set your debt load at no more than 10% of gross revenue.   This means that your debt load for this crew can not exceed more than $12,500 annually or $1,041 per month.  If your debt load threshold was 5% the monthly threshold would be  $520 per month.  Let’s  assume you goal is pay back your equipment in 4 years.  At a 10% debt load you can spend $50,000 on equipment to get your crew up and operating.

This is a great way to make a very quick and easy check to see if you can finance growth in your business!

Have any questions or comments?   Leave them below in the comment section.  Join in the discussion today.

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By Corey Sedrel