How much debt is too much debt?
Q: My business can use an infusion of cash, and I’m considering a business loan. I already have some outstanding debts, though. How do I strike a balance when borrowing for my business? How much debt is too much debt for a business?
A: Borrowing money to fund an expansion or new venture can be necessary to run a business. But how much is too much? Here’s all you need to know about striking a balance when borrowing for your business:
What is debt capacity?
Debt capacity refers to the amount of money a business can reasonably borrow and pay back within a specified timeframe. A company can use its debt capacity to ascertain how much money it can borrow.
To determine the debt capacity of your business, use the debt-to-EBITDA ratio. This commonly used metric measures the amount of income a business can pay down debt before covering costs. It compares the total sum of a business’s long- and short-term obligations to its earnings before interest, taxes, depreciation, and amortization (EBITDA). Once you have both sums, divide the total debt by the EBITDA to determine your ratio.
What is a good debt/EBITDA ratio?
There is no across-the-board rule for a responsible debt/EBITDA ratio. For some industries, a debt/EBITDA exceeding three or four can be problematic, while others can afford a debt/EBITDA as high as 10. Once you’ve determined yours, comparing it to other industries is best.
How much debt is healthy?
You will likely not want to push your ratio to its limit, and you’ll need to choose how much money you are comfortable borrowing for your business. Here, too, there is no one-size-fits-all answer. Your business is unique, and its capacity for new debt is also individual. Harj Taggar, the co-founder and CEO of Triplebyte, says it’s more important for businesses to have a defined plan for debt than a definite number. Healthy debt for a business, he shares, is debt that will be used well.
Now you have the tools to determine how much debt is too much. Did you know Elevate has a full suite of business tools and resources? We are here to help. Find out more about Elevate Business.
