Share this:
Share this:
Many people see business finance debt as a sign of failure, but the truth is that personal debt and business debt are very different. In fact, business debt is normal.
Successfully managing debt for your small business is a delicate balance. It's about finding the right level of debt to support the growth of the business without pulling it down.
In this article, we’ll discuss five things to consider when finding the optimal amount of debt. But first, let’s unpack the stigma around debt for small businesses.
Taking on business debt is a common fear among small business owners. The stigma of personal debt is often applied to business debt. But this stigma can stop you from growing.
The financial experts at Square reported that about a third of the eligible business owners don’t accept Square loans because they don’t want to owe money.
What’s often overlooked is that most of the world’s biggest brands have used debt to fund their growth. For example, Apple’s total debt climbed from $35 billion in 2014 to $108 billion in 2019, with its debt-to-equity ratio rising from 0.3x to 1.2x. And while Apple’s debt increased tremendously, its shareholder equity dropped from $112 billion to $90 billion.
The takeaway here is that, when strategically used, debt can help grow your business.
After breaking past the debt stigma, you’ll need to find the right amount of debt for your small business. As mentioned before, this is a delicate balance. Here are 5 things to consider.
Think of your business like a pie. The debt-to-equity ratio tells you how much of your company you own (equity) versus how much is owed to others (debt).
What’s a Good Debt-to-Equity Ratio?
Ideally, for every one Rand of your money, you should have between one and one and a half Rands of debt, depending on the type of business you’re involved in. This 1:1,5 ratio keeps your company balanced and ensures you're not overborrowing.
You can read more about business ratios here.
It’s not just about how much you borrow. You should also consider how much interest you can comfortably pay without stretching your cash flow too thin.
A good rule of thumb here is to make sure your earnings are at least three times your interest expenses. If you’re paying R10 000 in interest each month, you should be earning at least R30 000.
The Debt Service Coverage Ratio (DSCR) is a fancy way of asking, “Can your business’s income cover all your debt payments?”
Typically, your business income should be at least 25% more than your debt payments. So, if you owe R10 000 each month, you should earn at least R12 500.
You also need to know how quickly you can pay off short-term debt. You do this by looking at how much money you have in the bank and how quickly you can turn assets into cash. The faster you can do this, the more easily you can handle sudden expenses or pay off short-term debt.
You should be able to cover your short-term liabilities twice over with your available assets. So, if you owe R500 000 in short-term payments, you should have R1 000 000 in easily accessible assets.
The stage of your business plays a big role in how much debt you should take on. This is what we advise depending on your business stage.
At the startup stage, you should be cautious with debt. It’s difficult to raise funding for an unproven business model and uncertain ability to repay debt. We recommend startups focus on equity while building a foundation.
If your business is expanding and you have steady sales, you can take on more business finance debt to fuel growth. However, SMEs may still struggle to access funding from traditional lenders. A business at this stage will benefit from innovative funding solutions like invoice financing.
Due to lower business risk, mature businesses have easy access to debt capital and can easily get funding from traditional lenders. Ironically, this is the phase of your business where you should aim to reduce debt and focus on stability as your growth stabilises.
There’s no universal answer to how much debt is right for your business. But by understanding a few key principles and reviewing your financial health, you can find a balance that works for you. Business debt can be a powerful tool for growth, especially for growing businesses with a proven track record. If your business is in this stage and would like to explore innovative funding options, contact us here.