Determine the ideal level of debt for a company to finance the strategic growth
After the recent financial cries in the U.S., almost all businesses, no matter big or small are being unable to manage their finances and are incessantly falling into outstanding debt. However, fortunately the exiting debt can be paid off by pursuing debt settlement with the help of debt settlement company where the attorney negotiates with the creditors on behalf of the organization to reduce the pay-off amount so that the latter can afford to pay off the debt as fast as possible.
However, although it’s true that debt can make the management fall into serious trouble, but at times it can be a powerful instrument for the management to finance their growth. But too much debt can also be detrimental and a constraint for the management to grow. So there should be a neat balance between the debt and the revenue generated by the management. So a manager should determine how much debt is acceptable to finance growth depending on the changes to financial ratios and other metrics.
Advantages and Disadvantages of debt:
Having debt can be proved to be beneficial for the management. It helps the management to bring in large amount of capital and to fund them in strategic growth. This enables them to boost up their revenue and profit margins. So debt allows managers to quickly pursue strategic growth.
On the other hand, using debt to finance strategic growth can cost the management more at the same time, since debt funds come with high interest, fees, and even commissions in certain cases. Also, overwhelming debt can become a continual financial threat in the event of financial hardships in future.
What should be the ideal level of debt?
There should be the ideal level of debt into your balance sheet. To determine that, company must compare key financial metrics against the averages for specific industry. This test will indicate how much debt your company can afford to have into its balance sheet.
Find out debt ratio and debt-to-equity ratio:
Debt ratio is a calculation that determines the total liabilities in compare to the total assets. So divide the total amount of debt you owe by the total assets on your balance sheet to find out the debt ratio.
Debt-to-equity ratio is also a simple calculation that compares the total debt owed to the total owners’ equity that comprises of invested funds and retained earnings. So divide your total amount of debt by your total owners’ equity to find out the debt-to-equity ratio.
Find out interest coverage and cash flow:
The interest coverage ratio is a calculation that helps you find out your gross profit in compare to your interest expenses. A company that is left with large amount of money after paying off the interest expenses can more likely repay the debt faster and can borrow larger amount in the future. So divide your gross profit by interest expenses to find out the interest coverage ratio.
The cash flow to debt ratio reveals cash receipts in compare to total amount of debt owed. This provides you with a clear picture of your ability to pay off the debt by taking out credit sales, capital gains and other non-cash income from the equation. So to find out the cash flow debt ratio, divide your operating cash flow by total debt.
In conclusion, determine the acceptable level of debt with the ratios mentioned above and maintain the level on your balance sheet to finance the strategic growth.