By: Michael Hoyle
Debt is one of the most common — and misunderstood — tools in business finance. Used wisely, it fuels growth, preserves cash flow, and creates opportunity. Used carelessly, it can quietly erode even a profitable company. The question we hear from clients regularly is a simple one: How much is too much? The honest answer is: it depends. But there are clear benchmarks and principles we use to help you find the right answer for your specific situation.
Debt Isn’t the Enemy — Unmanageable Debt Is
Many business owners operate with the instinct that all debt is bad and should be eliminated as fast as possible. While that discipline has its place, it can actually slow down a healthy business. Borrowing at 6% to fund a product line that returns 20% is a sound strategy. The goal isn’t zero debt — it’s debt that works for you, not against you.
The danger zone begins when debt stops enabling your business and starts consuming it — when loan payments crowd out payroll, when refinancing becomes survival, or when a slow month triggers a cash crisis.
Key Ratios We Look At
When evaluating whether your business debt is at a healthy level, we focus on a handful of financial ratios. These aren’t abstract accounting concepts — they’re practical warning gauges:
- Debt-to-Equity Ratio (D/E): This compares what you owe to what you own. A ratio below 1.0 is generally considered conservative. A ratio between 1.0 and 2.0 is common and manageable in many industries. Above 3.0 often raises red flags with lenders — and with us. Capital-intensive industries like manufacturing or real estate can sustain higher ratios than service businesses.
- Debt Service Coverage Ratio (DSCR): This measures whether your operating income can cover your debt payments. A DSCR of 1.25 or higher is typically what lenders require — meaning for every $1.00 in debt service, you’re generating $1.25 in operating income. If you’re below 1.0, your business cannot cover its debt from operations alone. That’s a serious warning sign.
- Debt as a Percentage of Revenue: A common rule of thumb is that total debt should not exceed 50% of annual revenue for most small businesses, though this varies widely. A business with $1M in annual revenue and $800K in debt is in a very different position than one with $1M in revenue and $150K in debt — even if both are technically profitable.
Good Debt vs. Warning Signs
Not all debt is equal. Here’s how we distinguish between debt that’s working and debt that deserves scrutiny:
Healthy signs: Debt tied to a specific asset or growth initiative, fixed monthly payments you can model well in advance, interest rates that are at or below market, and a clear payoff timeline.
Warning signs: Revolving lines of credit that never seem to go down, short-term debt used to fund long-term needs, variable rates that have been creeping upward, debt taken on to cover operating losses (not investments), and borrowing from one source to pay another.
Industry Context Matters
There is no single “right” number that works for every business. A restaurant, a construction company, a professional services firm, and a retail shop all have different cost structures, revenue patterns, and asset bases. When we review a client’s debt position, we always compare it to industry benchmarks — not just generic rules of thumb. Your local competitor may carry twice your debt load and be perfectly healthy because their margins and receivables cycle look completely different.
Practical Steps to Take Right Now
If you’re unsure where you stand, here are a few things worth doing today:
- List every debt obligation — balance, rate, payment, and maturity date. Many business owners are surprised when they see the full picture in one place.
- Calculate your DSCR using your most recent 12 months of operating income and annual debt service. If it’s below 1.25, we should talk.
- Identify any high-rate or short-term debt that could be refinanced at better terms. The rate environment has shifted significantly over the past few years — a review may reveal opportunities.
- Talk to us before taking on new debt. Whether it’s an SBA loan, equipment financing, or a line of credit, we can help you model the impact before you sign.
Debt management is one of the most impactful areas where good financial guidance makes a real difference. Whether you’re feeling stretched thin or simply want a second set of eyes on your balance sheet, the team at Hoyle & Company is here to help you think it through.
Questions? Contact us to schedule a review of your business financials.
