Getting loans to finance your business is great, we always want to get more and more of it. But as you may already be aware, it has two effects on your business; bad and good and the effect that you get is usually as a result of how well you’ve managed it.
One helpful way to manage your debt is to know when it is too much for your business. You have to be able to monitor your business debt level so it does not become too much for your business to afford.
Of course, there are many symptoms of a business that is getting into too much debt that it can carry; you are missing payments or delaying payments, you have a poor cash flow etc.
But to be sure, here are a few metrics you can use to know:
Debt-to-income ratio takes a look at how much a business owes versus how much it earns over a while, usually a month. To calculate your DTI, divide your total monthly expenses by total gross monthly income of your small business. Using your debt-to-income ratio, if your debt is more than 50% of your gross income then it is too much already. It means that half your monthly income would go into debt repayment and that is not healthy. Lenders typically recommend a DTI ratio of 36% or less. But you can improve this ratio by reducing your debt or increase your income or both.
How well can your small business pay its debt if it was due today? That’s the question that the Net debt metric tries to answer. It shows how much cash the business would have left if all debts were paid off and whether your business has enough cash to meet its debt commitments. To calculate the Net Debt for your business. Use this formula:
Net Debt = Short Term Debt (STD) + Long Term Debt (LTD) – Cash & Cash Equivalent (CCE).
Your Debt to EBITDA ratio is similar to the debt to income ratio. The only difference is that Debt to EBITDA (which means earnings before interest, taxes, depreciation, and amortization) is the amount of money a business has earned which is available for debt repayment before covering interest, taxes, depreciation, and amortization expenses. The ratio shows how much cash-flow the business has to cover its debt and other liabilities. To calculate the Debt to EBITDA ratio, divide the sum of your debt commitments by EBITDA. The lower the debt-to EBITDA ratio over time indicates that a business is paying off its debt or increasing its income or both.