Debt is a critical tool in running businesses. Every company takes on debt in order to establish and grow the enterprise. While all companies are alike in absorbing debt in some form, they are different in how they manage their debt ratio. This can ultimately spell the difference between business success and failure.
Generally speaking, a lower debt ratio enhances your company’s chances of gaining a commercial loan. Typically, debt ratio is calculated by dividing total liabilities by total assets. The lower debt ratio signals potential lenders the company is not overleveraged and shouldn’t have difficulty paying back any loan awarded. For this reason, companies wanting a commercial loan to grow should be proactive in evaluating and managing their debt ratio.
Here are some key considerations in helping companies size up and manage debt ratios.
- Everything is relative. Whether a company’s debt ratio is regarded as high or low depends on the type of industry in which the company competes. Debt ratios tend to be very high, for example, in pipeline companies and utilities, and lower in technology. Your debt ratio is evaluated against industry averages.
- Increase sales revenues. Managing your company debt ratio means keeping it reasonably low. One common way to do that is to generate more sales revenues, either by growing unit sales or increasing prices, resulting in greater cash inflow.
- Reduce inventory. Managing debt ratio often includes improving inventory management. Maintaining unnecessary inventory levels can hike debt ratios and hamstring your ability to take on additional debt.
Simply put, a better debt ratio can make you more appealing to lenders. Holding less debt relative to assets also makes good business sense, which is icing on the cake.
If you have any questions about evaluating or managing debt ratio, let’s talk.