How Much Debt Should a Firm Have?

Appropriate levels of debt vary by business model, but amounts should be well-managed.

Carrying Minimal Debt Reduces Risk

A high amount of long-term debt is usually viewed as a trouble sign, especially for companies with modest cash and assets. Companies that operate on low to no debt models may have limited growth potential, but they also have reduced risk. Fashion and apparel specialty shop The Buckle, Inc., is an example of a sizeble and profitable company that carries little major debt.

Good Debt Generates Growth

Debt is not always a bad word in business. Debt that is used for profitable business production or growth can be beneficial. If leverage ratios are kept at reasonable levels, the use of debt to acquire equipment, product or other resources to grow your business can help your company expand more quickly and effectively than relying solely on cash. The ideal is to have the debt you're taking on generating money at a greater rate than the interest you're paying on it.

Bottom Line

The amount of debt you carry should be based on your business model, accurate risk-management principles and well-planned strategies. Monitor your balance sheet and income statement to ensure that you can easily make debt payments to avoid loan defaults and bankruptcy.

References

• Bplans: Good Debt vs. Bad Debt
• Zacks: The Buckle, Inc.

Resources

• AllBusiness: Types of Business Loans