What Does Your Debt-to-Equity Ratio Mean to Your Business?

ACHIEVING THE CORRECT balance will keep your business healthy and ready for growth.

No business can survive well without adequate funding to sustain growth and maintain working capital during times of the year when cashflow is tight. Even the most profitable jewelry store is very dependent on December trading for most of the annual profit and needs additional financial support during the remaining eleven months to keep the business running smoothly.

When it comes to securing financing, most businesses are faced with two choices: debt provided from an outside source, or equity — funds contributed by the owner (or additional owners if it is decided to bring someone else on board).

The ratio of debt to equity is one of the most important measures of a business’s financial health. Too much debt can create pressure on the business to service the cost of carrying it. Equally, too little debt for a successful business may mean it’s missing the opportunity to maximize returns where the interest rate is lower than the return on investment that the funds can generate.

This balancing act needs to be revisited from time to time as the ratio between the two does not stay steady by itself. Retaining profits in the business can grow equity, which provides funds for growth. However, this may have its tax disadvantages if you then use debt to fund personal expenses. Likewise, a drop in equity due to excessive personal cash withdrawals or the company sustaining losses can see the debt ratio become too high relative to the owner’s contribution to the business.

The last twelve months have presented challenging times for many business owners, and with closures and lockdowns, many are in a situation where they have had to rely on outside funding to keep their business going. Now that the future is looking a little more optimistic and a return to normal trading is on the way, it’s the ideal time to revisit your balance sheet and see where you stand for the trading ahead.

You may have run your inventory down because of Covid, and in order to meet sales targets, you may need to revisit your current range and depth of product in-store. With interest rates at historic lows, now may be a very good time to secure some additional funding in order to prepare yourself for what’s needed. Likewise, if you have been holding onto cash and building up the equity in your business, it might be time to determine how these funds can be better deployed for maximum results.

Either way, a review of your balance sheet will show how you can best prepare for the opportunities ahead.