Posts Tagged ‘debt-to-equity ratio’

Debt Can Kill Growth

It is very common for companies to go into debt to finance growth. Is that always a good idea?

Debt-A Financial Demon

Many a person has purchased something like furniture on credit. Now, there is nothing inherently wrong with that, especially if they have ample income to make the monthly payments. However, many learn some very important lessons they hopefully will never forget. Perhaps after three or four months of making payments they realize how they hate making those payments. Not only that, these payments can restrict what they can do as the payments cannot be avoided, at least if they want to build and maintain a good credit rating. They may even find that the furniture they bought no longer looks as good to them as it did. But, this is just on the personal level. When it comes to business, debt can kill growth for similar reasons.

Servicing Debt

Servicing debt means making the agreed to payments of interest and principle. If cash flow is adequate this may not be difficult. But, if the total obligations that a company has for expenditures of any kind becomes excessive then a cash crisis can easily develop. When that happens the company may be surviving day-to-day. It’s easy to see why debt can kill growth. Any time a company considers taking on additional debt they need to ask a few fundamental questions, such as:

  • Will the cash generated be sufficient to cover payment?
  • What is the payback time for the debt?
  • If the debt is for something like equipment, how long will it take before they recover the cost through additional sales and profit?
  • Is there an alternative?

One example of how timing is an issue has to do with depreciation. Perhaps equipment is purchased using a three year note payable. If this equipment is depreciation over say five years then the depreciation deduction is insufficient during those three years of note payments to offset them. In that case the additional sales or efficiency the equipment contributes needs to be sufficient.

Some Key Things to Monitor

If you do find that your company needs to go into debt, be sure to consider a few key ratios, such as debt-to-equity, debt leverage ratio and debt coverage (see Debt Coverage). Since debt can kill growth, be certain you can justify it. One other thing to keep in mind is that anytime your company has debt it opens the door to additional pressure from outside the company.

If you want to know more, contact AimCFO – Contact

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Actual Company Debt

Do you really know your actual company debt? This may seem like a silly question, but there is more to it than you may think. Let me explain.

Leases

There is a proposal from U.S. and international accounting regulators to change how a company should record and account for what is referred to as operating leases. Here I just want to consider the impact on the lessee. First, let’s look at some Read the rest of this entry »

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Why Debt Ratios Matter

If you don’t have a handle on your company’s debt you may find yourself without a company. Here are a few things to consider.

Types of Debt

There are two sources of capitalization for a company. One is owner equity and the other is debt. First let’s consider debt.

Debt may be in a number of forms, with bank loans to bonds being among them. An asset-based loan could be from a bank or other financing organization and Read the rest of this entry »

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