Maybe your company faces a short-term cash shortfall. Perhaps a key opportunity looms, and you'll need more capital to take advantage. Whatever the reason, like almost all companies yours will likely someday have to borrow to grow.
The decision to borrow can be relatively simple. But the issue of how much to borrow can put you on a tightrope. You don't want to become overextended and struggle servicing debt. But you don't want to borrow too little and be unable to meet growth opportunities head-on. Your banker can help you determine an optimal level of debt, based on your requirements and current finances.
Also consider these factors when deciding.
- Think long term. The capital borrowed should ensure not just a brief surge, but long-term revenue and profit growth. If you're certain the loan could yield a long-term upward trend line, borrowing more rather than less may make sense. After all, you'll have greater profits in the future to service the debt.
- Do the math. Examining the numbers banks scrutinize can help you learn the right amount. The Debt Service Coverage (DSC) ratio for your business determines how much of your cash flow will be left to service debt after paying expenses. To calculate the DSC ratio, determine the amount of cash your business generates monthly after paying regular operating expenses, and divide that number by the amount of the monthly payment for the new debt. If this DSC ratio is significantly greater than 1, you will have shown the Bank that your normal cash flow will provide you with the capacity to pay back the loan.
- Expect the unexpected. Unforeseen setbacks are a fact of life for any business. Before you borrow, consider potential obstacles. Is your debt level already high? Is a slow sales season upcoming? Scale back the loan amount to allow for disappointments -- some say by as much as half.
Determining the right loan amount is difficult. However, upfront research can help ensure you strike a balance between too much and too little.
How would you determine how much to borrow?