How to control the debt ratio? 

debt ratio

All business leaders are faced with the same dilemma: how much to borrow to invest and develop the business while controlling the overall level of indebtedness? No one wants to miss a growth opportunity. However, we must be sure not to take disproportionate risks in the event of an unforeseen development. Here are the financial indicators that will allow you to correctly assess the benefit/risk ratio.

What is the debt ratio?

Can your company still go into debt? To find out, the essential indicator is the debt ratio.

Wondering what the debt ratio is? It is obtained by dividing total liabilities by total assets and indicates as a percentage the total amount of assets (as presented on the balance sheet) due to creditors.

By comparing liabilities and assets, the debt ratio makes it possible to identify the level of dependence of the company vis-à-vis third parties. Your banker will carefully examine this ratio before granting you new loans. The lower the ratio, the less debt the company has.

Tip: Other than this general guideline, there are no hard and fast rules to define a good or a bad debt ratio. Some activity areas, such as metallurgy, construction, energy, and agribusiness, are usually more indebted than others.

Explanations in support of the debt ratio

If monitoring the debt ratio is essential to measure exposure to financial risks, it is imperative to study this indicator in the particular context of your company. The ratio must be included in your presentation to convince your interlocutors and potential financial partners.

An innovative business in the start-up phase will undoubtedly have a high debt ratio. A few months later, if the business has grown, revenue streams should begin to ease the debt.

Tip: It’s important to look beyond the numbers to consider how long the business has been in business and what stage it is at. For example, a higher debt ratio, because a company has modernized its fleet of machines or vehicles, will be perceived more positively than a lower ratio because the company has not invested. Indeed, investment spending tends to indicate the anticipation of growth.

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Optimize your funding sources

Precise figures associated with a clear presentation of the company’s past achievements are real assets when entering into a relationship with a new financial partner. Each individual business can access different types of financing.

The first, and the most classic, remains the bank loan. The bank loan is often used to finance long-term investments, such as the purchase of premises or equipment necessary for the activity.

Leasing and authorized overdrafts can also be used to finance short-term expenses in order to optimize cash flow, but this type of financing is generally subject to higher interest rates than long-term loans and should not be used to cover operating expenses indefinitely.

There are other sources of liquidity for businesses than traditional bank loans. Investors, business angels, investment funds looking for atypical opportunities with sound business plans, even participatory financing or “crowdfunding”, are all new ways of attracting capital investment.

In this case, your company does not incur any cash debt. Instead, you give shares of your business to your investors, giving up some control over your business in return for a financial investment to help you achieve your goals. But beware! You need to choose your investors carefully: make sure you share the same vision and goals. In the event of a discrepancy, you run into real conflicts that could be difficult to resolve.

advice: in order to optimize your sources of funding, it may be wise to diversify the sources of contributions. But beware: not all of them serve the same purposes. Bank loans are a long-term commitment and can be used to buy premises or develop new activities, but bringing in new investors can be a way to complete large transactions, such as buying out a competitor.

Few companies can grow without going into debt. The important thing is that the investments made possible by this debt support your growth without slowing it down. It’s all about balance!

By aamritri

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