Best Practices for Managing Business Debt Ratios
Contents
Best Practices for Managing Business Debt Ratios
Monitor Key Debt Ratios
Some important debt ratios to track regularly include:
- Debt-to-Equity Ratio – Measures the amount of debt financing relative to equity financing. Aim to keep this below 1.0.
- Debt-to-Assets Ratio – Shows what percentage of assets are financed through debt. Try to keep this under 50%.
- Debt Service Coverage Ratio – Indicates if there is enough cash flow to cover debt payments. Shoot for at least 1.2.
Use financial modeling and forecasting to predict how changes in business activity and investments may impact these ratios over time. This allows you to proactively make adjustments if needed.
Have a Debt Management Plan
Outline guidelines and limits for taking on and maintaining debt. For example:
- Debt should primarily be used only to generate future cash flows, not to finance existing operations.
- Set a maximum debt-to-equity ratio limit for the company.
- Establish target debt service coverage ratios based on cash flow stability.
- Diversify between short-term and long-term debt instruments.
Sticking to a formal plan prevents emotionally driven decision making when it comes to debt.
Negotiate Favorable Terms
Work with lenders to negotiate the best possible terms on new debt:
- Get the lowest interest rates possible based on the company’s creditworthiness. Online lenders like LendingClub or Funding Circle often offer competitive rates.
- Minimize fees associated with establishing lines of credit or loans.
- Extend payment periods/maturity dates on loans to preserve short-term financial flexibility.
Proactively managing relationships with lenders gives more leverage in negotiating debt contracts.
Maintain Strong Credit Rating
A higher credit score means better terms for business debt. Ways to preserve great credit include:
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- Paying all bills on time. Set calendar reminders for payment due dates.
- Keeping credit utilization below 30% by limiting new credit applications and overall debt balances.
- Correcting any reporting errors with creditors that may impact scores.
- Only applying for new credit when needed to get the best rates on future debt.
Consistently demonstrating fiscal responsibility leads to improved rates/terms over the long run.
Let me know if you need any clarification or have additional questions!