Small Business Financial Article

With everything business owners have on their plate, it’s often difficult to know whether they have the capacity to expand should the opportunity arise. To know for sure requires a firm grasp of the business’s financials, and often, it’s not until loan applications are submitted to multiple lenders that the answer is clear. All the time and effort spent getting an answer can cost business opportunities.

Business owners can stay out of the dark on this issue by having constant access to the business’s debt capacity, which is a measure of the business’s capacity to take on more debt.

What Exactly is Debt Capacity?

Essentially, debt capacity measures the amount of debt your business can handle at any one time while maintaining the ability to repay it under the terms of the loan. It’s an important measure because lenders consider it in determining whether a business can generate enough cash flow to repay the loan on time.

An analysis of debt capacity begins with a business’s cash flow statements and balance sheet. A key metric in the analysis is EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization). Businesses with strong EBITDA are considered better risks because of their capacity to generate sufficient earnings that can be allocated to loan repayment. Lenders look at the debt-to-EBITDA ratio to assess debt capacity. The debt-to-equity ratio, found in the balance sheet, is also an important metric.

How Knowing Debt Capacity Helps Your Financial Management

Having a constant awareness of your debt capacity, which can change periodically, can help your business in the following ways:

More Meaningful Strategic Planning

It’s not uncommon for a management team to spend time and resources developing a strategic plan only to find out they can’t obtain the funding to implement it. With an awareness of your business’s debt capacity, strategic planning becomes more meaningful and efficient.

Be Ready for Opportunities

You never know when an opportunity will arise and, when it does, whether you will have the capacity to fund it. If you are unaware of your debt capacity, the opportunity may pass you if you can’t get a quick answer from your lender.

Speed Up the Lending Process

When you need to take out a loan, it could require several meetings with your lender to answer questions. If you don’t have the information the lender needs, it raises more questions and causes another delay in determining how much you can borrow. Knowing your debt capacity will help you get past many preliminary questions and to your approved loan amount more quickly.

If you want to be ready for the next opportunity, meeting with your business bank specialist to learn how to calculate your debt capacity would be worthwhile. That way, you can assess your capacity to borrow wellin advance ofyour need.