How Much Debt Is Enough? Too Much?
How much debt is too much? Should you ever be debt free? What are some good guidelines for how much a business should be leveraged?
Over the years and after working with many different print shops, I have come up with what I believe are some good guidelines.
First, let me point out that I am expressing these guidelines or ratios as a percentage of sales. Further, I am defining these costs as debt/loan payments the business must service. This would include any loan payments to lending institutions and/or any lease payments. This does not reflect any depreciation since it is not a cash expense.
Because of the tax rules dealing with depreciation, including it as “debt service” or “capital costs” can be misleading. Instead, I choose to view this from the perspective of cash flow capital cost.
Here are my guidelines:
- Less than 5 percent—You are likely milking the cash cow and probably not investing enough to keep the business healthy. Do this too long and you become a dinosaur.
- 5-10 percent—You are about right to maintain a healthy business and still have good cash flow.
- More than 10 percent—You’re either in a heavy “invest for the future” mode or you may be over-leveraged and headed for trouble.
Being in any of these three categories can be part of a good plan if it is done strategically and purposefully.
If you want to build cash and not worry about the long-term, it might be acceptable to “milk the cash cow” with little or no debt service. Of course, this also means you may end up with a business that has little value when you get ready to sell. Contrary to some opinions, pushing up the bottom line before you sell might backfire if the business is not well-positioned for the future.