Business Financing Problems

A business needs positive cash flow to make payroll, cover monthly expenses, provide working capital, expand sales and ultimately grow. The more cash flow a company has over and above its expenses the healthier it will be. Most business financing problems occur when there is a lack of cash flow or when the business has taken on too much debt.

Not Enough Cash Flow

Cash flow is calculated by subtracting total expenses from total income. If the resulting number is positive, the company is turning a profit, and is considered to “be in the black.” If the resulting number is negative, the business is losing money and considered to be “in the red.” Businesses with only modest cash flow may find it hard to expand their operations, and businesses with negative cash flow have even fewer options. If a business lacks the ability to create cash flow, it will be forced to take on debt to continue operations. Business loans can help a company restructure, retool, increase sales or expand into new markets. However, too much debt can sink a business permanently.

Too Much Debt

Too much debt can be detrimental to a business. High credit card interest rates and large loan payments can raise your monthly expenses, and make it harder to turn a profit. Few banks will approve loans for businesses with too much outstanding debt. If a business reaches a point where the debts and liabilities outweigh revenue and cash flow, the business is deemed to be insolvent and bankruptcy may be the only recourse.

Poor Financial Management

All businesses, especially startups, need a business plan and a financial budget to guide how they raise and spend money, and how they handle financial surpluses and shortfalls. Companies that fail to properly research their markets, underestimate competition or overspend wildly will have problems meeting their revenue goals, and may risk the overall health and viability of the business. Financiers like to lend money to companies with track records of responsible fiscal management and often decline loans to businesses that show a failure to plan ahead.

Debt to Equity Ratio

The “Debt to Equity Ratio” tells you how much debt (liabilities) you have compared with how much equity (cash) exists in your company. It is calculated by dividing the total business debt by the total equity. A number of 5.0 tells you that the business has five times as much debt as equity in the company. A number of 0.5 tells you the business has half as much debt as equity, or twice as much equity as debt. The debt to equity ratio can vary from industry to industry depending on the cost structure of the business and its reliance on debt. However, in all cases, a smaller debt to equity ratio is better.

Debt Coverage Ratio

The “Debt Coverage Ratio,” also known as DCR, is a ratio of the company’s net operating income to its debt payments. It is expressed as a whole number, and the larger that number is the better. A DCR of 2.0 means your company has twice as much net operating income as it does debt payments each period. A number of less than 1.0 would signal negative cash flow.

Know When to Raise Alarm

Paying close attention to the company’s business plan and budget will help keep expenses in check and ensure positive cash flow. The key business ratios serve as an alarm for your business. Understanding what they are and how they work can prevent your finances from getting out of control.

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