How much debt can your company handle?

In spite of the fact that there are common complaints regarding the fact that there is a lack of money available for start-up companies, there are sources of capital on offer. The only issue is that not all sources are suitable for every type of business. More precisely, the choice will depend largely on the industry or even the region your business is. There are two main types of capital: equity and debt. They are completely unlike and since they have different effects on your business you should consult with chartered accountants, namely professionals in the field of finance and finance. If you want to find out if debt finance is the right type of funding for your business needs, read this article.

How much debt can your company handle

Definition of debt finance

According to the Bank of England, small firms are financed through internal finance, but the fact is that about 39% of them seek external funding. The vast majority of small businesses are funded by a bank loan, which is the most typical form of debt financing. As a general rule, the debt is secured against an asset, which means that if your business is in the impossibility of repaying the loan, the lender has the right to claim the asset. The asset can be represented by either a house, other premises or even the equipment of the company. Once the loan is secured, the cost will be significantly less than other types of borrowing, which are also risky.

An option to selling

Debt is usually thought of as a scandalous word, but the truth is that debt can actually optimise your company’s capital structure. But why would you want to increase the company’s debt load in the first place? If you have a clean balance sheet, leveraging the assets could be the only solution to unlocking cash that you can use to pay the shareholders through dividends. Nonetheless, too much debt increases your financial risk because you are locked into a payment schedule and this will leave your company unable to meets its obligations.

Debt/equity proportion

A strong balance sheet is important for any shareholder owing to the fact that it reflects the strength of the company. Your company’s capitalisation gives an account of the company’s long-term or permanent capital, meaning the combination of debt and equity. If the debt/equity ratio is high, then your business has borrowed a lot of money based on small based of investments. This basically means that the lenders are more exposed to problems than the investors are. In this situation, equilibrium is established based on market performance and forces. The fact is that the more you have invested in the business, the easier it will be to attract debt financing. On the other hand, if your company has a high proportion of debt to equity, you should increase your ownership capital.

Including debt in the capital structure

If you have the opportunity to introduce debt into the capital structure, you should not do this in order to reduce the average cost of capital. It is obvious that the debt that your company can handle is a subjective matter taking into consideration that you have to consider certain aspects, such as the tangible assets that will be used to support the debt, your ability to service the debt with cash flow and, last but not least, qualitative factors.

Balancing the debt load

In order to debt load the capital structure, it is necessary to take into account the overall cash flow capabilities of your company and your ability to service debt. Overall, a conscientious use of debt is usually the best alternative to monetisation. You should not try selling your business before even trying to create optimal capital structure. The answer to your problem lies in determining where the benefits of the debt on the balance sheet outweigh the financial risks.