How Much Debt Should a Business Have?

Striking the right balance between business debt and equity is paramount for maintaining financial health and sustaining growth.

Mar 12, 2024

How Much Debt Should a Business Have

While debt can be a powerful tool for funding expansion and capital investment, excessive borrowing can pose significant risks to a company's stability. Conversely, too little debt may hinder a business's ability to seize growth opportunities or weather economic downturns. 

In this article, we will explore the factors that influence the optimal debt level for businesses, offering insights and strategies to help companies navigate this critical aspect of financial management.

Key Highlights

  • Finding the right amount of debt for a business involves weighing industry standards, growth expectations, and economic conditions. 
  • While debt can drive growth, too much can jeopardize financial stability. 
  • With a strategic debt management plan tailored to their needs, businesses can navigate these factors and secure a path to long-term success.

Calculating the Optimal Debt-to-Equity Ratio

Calculating the ideal debt-to-equity ratio involves assessing a company's financial structure to balance debt and shareholder equity, minimising risk and maximising returns. This includes analysing financial metrics and industry benchmarks to make informed decisions regarding their capital structure.

The formula for the debt-to-equity ratio is total debt (both short-term and long-term liabilities, such as loans, bonds, and lines of credit) divided by total shareholder equity:

Debt-to-equity ratio = Total liabilities / Total shareholders' equity

Check the balance sheet for the total liabilities and shareholder equity. Remember, shareholder equity equals assets minus liabilities, which are all available on the balance sheet.

With the debt-to-equity ratio formula, divide the company's total liabilities by its total shareholder equity to get the ratio.

A low debt-to-equity ratio indicates that a company relies less on debt financing and may be less risky, but it could also mean missed growth opportunities.

On the contrary, a high debt-to-equity ratio suggests that a company relies heavily on debt, which can increase financial risk but potentially lead to higher returns.

Debt-to-equity ratio Calculations Example

Using the aforementioned formula, let's examine a scenario in which a company has total liabilities of $7,000 and total shareholders' equity of $3,000. The debt-to-equity ratio can be computed as follows: $7,000 divided by $3,000 equals 2.3.

Now, let’s illustrate it with another example. Imagine a company with £50,000 in total liabilities and £100,000 in shareholder equity. Applying the formula, the debt-to-equity ratio can be calculated as follows:

£50,000 / £100,000 = 0.5.

This indicates that the company has £0.50 in debt for every £1 of shareholder equity.

Good Debt vs Bad Debt

Differentiating between good and bad debt is crucial for businesses' financial choices. Good debt fuels growth and profitability, such as expansion or research and development investments. Bad debt, conversely, comprises financial commitments that fail to enhance operations or generate returns, like unpaid customer invoices or irrecoverable loans.

When evaluating debt, businesses should weigh factors like interest rates, repayment terms, and potential returns. Effective debt management entails reducing bad debt and optimising the benefits of good debt.

Businesses can reduce bad debt through tactics like credit checks and stricter payment terms. On the other hand, strategically using good debt means evaluating growth opportunities and resource allocation. Finding the balance between good and bad debt is vital for financial well-being.

Book a Meeting With Experts for Effective Business Debt Management

Factors Influencing Optimal Business Debt Level

Several factors influence the optimal debt level for a business, including the company's industry, growth stage, and risk tolerance. External factors, such as interest rates and economic conditions, can also significantly impact it. Understanding these factors is crucial for businesses to determine the right amount of debt to support their operations and growth.

Economic Indicators

Interest rates, inflation rates, and overall economic stability can impact borrowing costs and repayment obligations. In times of low interest rates, businesses may find it more favourable to borrow funds to finance expansion projects or capital investments.

During high inflation, businesses may choose less debt to mitigate the risk of increased interest expenses eating into profits. Economic indicators like GDP growth and consumer confidence can also impact market demand and revenue generation, affecting a business's debt service capability.

Industry Benchmarks

Sectors with higher capital intensity may demand greater debt for operational needs and competitiveness. Meanwhile, industries with lower capital requirements may benefit from lower debt levels to avoid excessive financial risk. Examining industry benchmarks enables businesses to compare their debt levels with peers and adapt financial strategies accordingly.

In addition, industry-specific factors such as regulatory requirements and market dynamics can influence the ideal debt level for businesses within a particular sector.

Growth Projections

A company's growth trajectory affects its capital requirements for expansion. Those anticipating rapid growth might favour higher debt levels to finance investments, like infrastructure or market expansion. On the other hand, businesses with conservative growth projections may choose lower debt levels to mitigate risk.

Reviewing growth projections helps businesses match debt levels with expected revenue and operational needs. Incorrect growth predictions can lead to underinvestment, limiting growth, or excessive debt, jeopardising stability. Thus, regularly updating projections is vital for maintaining optimal debt amounts.

Strategies for Managing Business Debt

Managing business debt requires careful planning and strategic decision-making; and refinancing and cash flow optimisation are vital strategies.

  • Refinancing options

Refinancing options offer businesses opportunities to improve their debt management strategies.

One common approach is negotiating lower interest rates with existing lenders or seeking alternative financing options with more favourable terms.

Additionally, businesses can explore debt consolidation, combining multiple debts into a single loan with a lower interest rate.

Refinancing offers extended repayment terms, easing immediate financial strain and offering debt management flexibility. However, businesses must consider associated costs and align refinancing decisions with long-term goals. All in all, it aids in reducing debt-related expenses, bolstering cash flow, and fortifying financial stability.

  • Cash flow optimisation

Businesses can manage debt levels through cash flow optimisation. One effective strategy is to implement stringent credit policies to ensure timely customer payments, thus improving cash inflow. Another solution is negotiating favourable payment terms with suppliers to align outgoing payments with cash inflow, reducing the strain on working capital.

Regularly reviewing and trimming unnecessary expenses helps conserve cash and improve liquidity.

Businesses can use alternative financing like asset-based lending or invoice financing for immediate cash flow without increasing debt. Maintaining cash reserves is crucial to cover unexpected expenses, and cash flow forecasting helps plan debt repayment effectively.

Contact Payfor for Commercial Debt Collection


Giles Goodman - Payfor CEOAuthor: Giles Goodman, Founder CEO of Payfor Limited
Drawing from his solid experience in commercial debt collection, Giles
offers invaluable expertise in solving claims owed between companies worldwide. Through his writing,
Giles shares insights tailored to business owners, leveraging his wealth of experience to provide practical
guidance and support.

Linkedin Logo LinkedIn

Disclaimer:

This blog post is intended for informational purposes only and should not be construed as legal advice. The information provided in this post is based on general principles and may not apply to specific legal situations. Laws and regulations vary by jurisdiction and can change over time. Readers are advised to seek professional legal counsel before making any decisions based on the information provided in this blog post. Payfor Ltd is not a law firm and does not provide legal services. The company disclaims any liability for actions taken based on the contents of this blog post.

More Blogs & Insights

Negotiation Tactics in Debt Recovery

Negotiation Tactics in Debt Recovery: The Psychology of Persuasion.


Commercial debt recovery is an essential, yet intricate, facet of business operations that requires an amalgamation of skills—from legal understanding to business acumen.

How to Recover Debt in the US When You're in Ukraine

How to Recover Debt in the US When You're in Ukraine?

Navigating the complexities of debt recovery across international borders presents unique challenges for businesses, particularly when seeking to recover debts owed in the United States while operating from Ukraine.

legal debt recovery as a strategic imperative

Is Legal Recovery the Answer When Your Business is Owed Money Across Borders?

When your business faces the challenge of recovering owed money from companies operating across international borders, legal recovery emerges as a strategic imperative.

Commercial Debt Collection Recovery Campaigns

How Do Commercial Debt Collection Recovery Campaigns Work?

Commercial debt collection recovery campaigns are intricate processes designed to retrieve outstanding debts owed by businesses to creditors.

Jurisdiction in Commercial Debt Collection

Why Jurisdiction Is the Most Critical Factor in Commercial Debt Collection?

When it comes to commercial debt collection, one question often trumps all others: "What is the key most important factor when chasing a debt?"

Arbitration vs Issuing Legal Proceedings

What is the Difference Between Arbitration and Issuing Legal Proceedings/Litigation?

The choice between arbitration and litigation is a pivotal decision that can shape the course of dispute resolution.

Amicable Commercial Debt Recovery

What is Amicable Recovery?

Amicable Recovery is a consensual and cooperative debt collection method that aims to settle outstanding payments without resorting to judicial measures. This process often commences with a courteous reminder, followed by mutually beneficial negotiations, in an effort to secure payment.

What is Jurisdiction in Global B2B Debt Collection

What is Jurisdiction in Global B2B Debt Collection?

Jurisdiction determines the legal authority and framework within which commercial debt collection efforts can be pursued across international borders.

Determine if a Debtor is Solvent

How to Determine if a Debtor is Solvent Enough to Repay Debt: An Expert Guide

In the intricate world of commercial debt collection, one of the most challenging yet imperative tasks is assessing the solvency of a debtor.

Small Business Debt Collection Guide

Small Business Debt Collection: A 7 Point Guide

This guide covers seven key points, ranging from understanding legal frameworks to negotiating payment plans. It equips small business owners with the knowledge and tools necessary to successfully pursue outstanding debts. 

Commercial Debt Collection Explained

What is Commercial Debt Collection?

Commercial debt collection is when a third-party agency recovers unpaid debts owed by one company to another. The recovery agency contacts the company owing the debt requiring it to pay the debt.

Commercial Debt Collection Challenges for US Companies

What Are Commercial Debt Collection Challenges for US Companies?

Commercial debt collection presents myriad challenges for US businesses, including complex jurisdictions and contractual elements.

How Much Debt Should a Business Have

How Much Debt Should a Business Have?

Striking the right balance between business debt and equity is paramount for maintaining financial health and sustaining growth.

Commercial Debt Collection Challenges and Solutions for Ukrainian Businesses

Commercial Debt Collection Challenges and Solutions for Ukrainian Businesses

In today's economic climate, Ukrainian companies encounter many obstacles when recovering commercial debts.

How is Bad Debt Defined in Business

How is Bad Debt Defined in Business: A Short Explanation

The term "bad debt" holds significant importance for businesses and can often signal trouble for enterprises of varying sizes.

What is a Creditor in Business

What is a Creditor in Business?

A creditor is a party that has provided goods, services, or monetary resources to a business on credit, expecting repayment within an agreed timeframe.

What is a Commercial Debt for Business

What is a Commercial Debt for Business?

Commercial debt is the amount of money one business entity owes to another for goods or services provided on credit terms.

What Should Businesses Expect From a Modern-Day Debt Recovery Agency

What Should Businesses Expect From a Modern-Day Debt Recovery Agency?

Modern debt recovery firms are redefining industry standards by offering strategic financial solutions alongside traditional collection efforts.

Expert Tips for Choosing Reliable B2B Partners

How to Safeguard Your Business: Expert Tips for Choosing Reliable B2B Partners and Clients

In today's rapidly evolving business landscape, establishing robust B2B partnerships and securing dependable clients are pivotal to achieving growth.

Commercial Debt Collection Challenges and Solutions for UK Companies

What Are Commercial Debt Collection Challenges and Solutions for UK Companies?

Navigating the complexities of commercial debt recovery in the UK presents many challenges that demand a strategic understanding and adept handling.

Debt Collection for AI Companies

A Comprehensive Guide to Commercial Debt Collection for AI Companies

As AI businesses often market their technology globally, cross-border trade is a notable challenge they face.

Commercial Debt Collection nuances for Recruitment Companies

How Does Commercial Debt Collection Work for Recruitment Companies?

As recruitment agencies strive to connect employers with suitable candidates, the issue of outstanding payments can become a common challenge for them.

Debt Collection Agencies

What are Debt Collection Agencies: Their Role in Financial Recovery

The debt collector is mainly an agency creditors hire to recover money owed by businesses that have failed to make timely payments on their debts.

Commercial Debt Collection Issues for IT and Software Development Companies

Commercial Debt Collection Issues for IT and Software Development Companies

The billing models, project timelines, and evolving client requirements create an environment where debt recovery becomes a complex and nuanced process for IT and Software development companies.

Maintaining Healthy B2B Relationships while Pursuing Debt Collection

Business Debt Collection Etiquette: How to Preserve B2B Relationships

In the ever-evolving landscape of business, maintaining positive relationships with other companies is crucial for long-term success. However, as businesses engage in commercial transactions, they may encounter instances where debtors are not forthcoming, acting in bad faith, or having a hidden agenda.

What is a Debtor

What is a Debtor in Business: Essential Guide

Commercial debtors, in essence, refer to entities that owe money to a business for goods or services provided. This financial relationship forms a critical component of the broader commercial ecosystem, shaping a business's cash flow dynamics and overall financial health. 

Global Debt Collection Explained

What is Global Debt Collection?

Global debt collection is when a collection agency or company actively tries to collect debts from debtors across international borders.

What to Do if a Company Owes You Money

What to Do if a Company Owes You Money: Resolving Unsettled Debts

In a business relationship, there might be situations where a company owes you money, and the path to resolution may not always be clear. When faced with this challenge, it's crucial to approach the situation with a level head and a strategic plan.

Top Challenges in Global Debt Collection

10 Global Debt Collection Challenges: How to Overcome Them

Identify the key challenges of global debt collection, from legal jurisdictions to assessing debtor's liquidity, and effective strategies for successful debt recovery.

Commercial Debt Collection Laws and Rules in the UK

Commercial Debt Collection Laws in the UK: A Comprehensive Guide

Understanding the legal framework governing commercial debt collection is paramount for both creditors seeking restitution and debtors aiming to protect their rights.

Corporate debt recovery

What is Corporate Recovery?

A Comprehensive Guide to Collecting £100k-£250k Unpaid Invoices from International Businesses

Two men handshaking over a satisfying debt settlement

How a Ukrainian company achieved a satisfying settlement

The Ukrainian company had done everything they needed...

Portuguese company's outstanding debt collection case study

How a Portuguese company got 80% of the outstanding debt collected

A recruitment company based in Portugal was owed money from clients in the UK, Portugal and Germany.

A software development company's outstanding debt negotiation

Indian software developer got that Payfor feeling

Payfor was able to collect the outstanding debt by negotiating a resolution between the two companies.

overcome frustrating debt collections

How we overcome frustrating debt collections

A Welsh SaaS business was owed money by a London financial services company.

Collect Debt From a Business That Repeatedly Refuses to Pay

How to Collect Debt From a Business That Repeatedly Refuses to Pay What They Owe

At the start of the Covid Pandemic in the UK early 2020, companies started owing each other money left, right and centre…

Payfor Commercial Debt Recovery Agency Logo

Your global 
recovery specialists.

Payfor's Google Ratings Image

Follow

Facebook white logoTwitter bird logoInstagram logo

Global Address

Number One, Vicarage Ln, London E15 4HF  

Copyright. Payfor 2024. London.