Are you looking into outside financing to grow your business? If so, there are several financial ratios used by banks to assess the health of your business. Read on to learn more about Business Debt Coverage.
Business Debt Coverage is a ratio that measures your company’s ability to repay business debt, providing a snapshot of the overall financial health of your business. The ratio compares your company’s cash flow to its total annual business debt payments. To calculate, divide your annual business cash flow by the annual business loan payments, including the anticipated payments you would make on the loan you’ve applied for.
Note that banks can use slightly different approaches when calculating Business Debt Coverage in terms of what expenses they include and how they define cash flow or debt.
Business Debt Coverage is important to SBA banks because it helps to assess if there is enough business cash flow to cover the payments for all business debts. In other words, do you have funds each month to pay back a loan? A high ratio indicates you’re better able to pay back debt and can take on more debt if necessary.
Once you’ve used the calculation above, you’ll determine the Business Debt Coverage ratio.
For example, a Business Debt Coverage of .95 means that there is only enough income to cover 95% of annual business debt payments.
The good news is that businesses can improve their Business Debt Coverage ratio in two ways:
1) Increasing cash flow
2) Decreasing debt
Cash flow problems can sink a business that might otherwise survive. According to a U.S. Bank study, 82 percent of business failures are due to poor cash management. Below are a few strategies you can use to increase your cash flow.
Billing can be a challenge for small business owners. Shortening your receivables, from 60 – 30 days for example, can boost cash flow. Encourage on-time payments by offering a small discount or instigating a penalty for late payers. Monitor receivables weekly or bi-weekly and follow-up on late receipts.
Are you staying in touch with your current customers and reaching out to potential customers? One easy way is to send an e-mail blast reminding customers about your products or services. For additional ways to increase marketing, visit the SmartBiz Small Business Blog and review this post:
Digital Marketing for Your Small Business
Fixed assets with monthly payments can cause negative cash flow. Vehicles, equipment and other necessary expenses fall into this category. Consider leasing to avoid depreciating assets. Do an overall cost analysis to determine if you’re getting the best deal possible for insurance, tech services, phone and other reoccurring expenses.
For an in-depth look at these strategies, check out this article on the SmartBiz Small Business Blog: Small Business Cash Flow Fixes
Another way to sink a business? Accumulate expensive or unnecessary debt. Here are several ways to reduce debt to improve your cash flow.
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