Business debt isn’t necessarily a bad thing.

A business may borrow money to purchase equipment, fund expansion, manage working capital, acquire another business or invest in opportunities that could generate future returns.

The problem begins when debt becomes difficult to manage.

For a small business owner, the important question isn’t simply “How much debt do I have?”

It’s:

“Can my business comfortably afford the debt it has taken on?”

The answer depends on cash flow, profitability, repayment commitments, interest costs, business assets, and the purpose of the borrowing.

Understanding these factors can help you make more informed decisions before taking on additional debt.

Is Business Debt Always a Bad Thing?

No.

Debt can be a useful financial tool when it is used appropriately.

For example, borrowing may allow a business to:

• Purchase productive equipment
• Fund a business expansion
• Purchase inventory
• Manage temporary working capital requirements
• Invest in technology
• Acquire another business
• Purchase commercial property

The key is whether the borrowing supports the business without creating an unsustainable repayment burden.

Debt used to generate productive returns can potentially support growth.

Debt used to cover operating losses continually can create a very different situation.

What Determines Whether Business Debt Is Too High?

There isn’t one universal debt limit that applies to every small business.

The appropriate level depends on factors such as:

• Revenue
• Profitability
• Cash flow
• Interest rates
• Loan repayment schedule
• Existing financial commitments
• Business assets
• Industry
• Revenue stability
• Future growth plans

A business with predictable recurring revenue may be able to manage debt differently from a seasonal business with highly variable income.

This is why debt should be assessed in the context of the entire business.

Look at Your Debt Compared With Your Cash Flow

One of the most important considerations is whether the business generates enough cash to meet its debt obligations.

Imagine a business has several loans with combined repayments of $15,000 per month.

If the business consistently generates significantly more than that after covering its normal operating expenses, the debt may be manageable.

If cash flow regularly falls below the required repayment amount, the business may be under financial pressure.

This is why cash flow can be more useful than revenue alone when assessing debt capacity.

Revenue Doesn’t Tell You Whether You Can Afford Debt

A business generating $2 million in annual revenue isn’t automatically in a better position to take on debt than a business generating $1 million.

Consider two businesses:

Business A

Revenue: $2 million
Profit: $100,000

Business B

Revenue: $1 million
Profit: $250,000

Business B generates less revenue but significantly more profit.

This illustrates why lenders and business owners need to consider profitability and cash flow rather than looking at sales alone.

Review Your Debt-to-Equity Position

One commonly used measure is the debt-to-equity ratio.

A simplified formula is:

Debt-to-Equity Ratio = Total Debt ÷ Shareholders’ Equity

For example, if a business has:

Total debt: $400,000
Equity: $800,000

The debt-to-equity ratio is:

0.5

This means the business has $0.50 of debt for every $1 of equity.

However, there is no single debt-to-equity ratio that is automatically appropriate for every business.

The acceptable level can vary considerably between industries and business models.

Consider Your Debt Service Coverage

Another useful concept is whether the business generates enough operating cash flow to cover its debt obligations.

This is often assessed using a Debt Service Coverage Ratio (DSCR).

A simplified calculation is:

DSCR = Cash Available for Debt Service ÷ Debt Service Obligations

For example, if a business has $240,000 available for debt service and annual debt repayments of $160,000:

DSCR = 1.5

This indicates that the business generates 1.5 times the amount required to meet its debt service obligations.

A higher ratio generally provides a greater buffer.

The appropriate level depends on the lender, business circumstances, and type of borrowing.

Don’t Forget Interest Costs

The cost of borrowing matters just as much as the amount borrowed.

Two businesses could have the same loan balance but very different financial commitments because they have different:

• Interest rates
• Loan terms
• Repayment structures
• Fixed or variable rates
• Fees

As interest rates or borrowing costs increase, the amount of cash required to service the debt can also increase.

This is particularly important when assessing variable-rate borrowing.

Look at Your Monthly Debt Commitments

Instead of focusing only on the total balance, understand exactly what the business needs to pay each month.

Create a list of:

• Loan repayments
• Equipment finance
• Vehicle finance
• Credit facilities
• Business credit cards
• Other financing arrangements

Then compare those commitments with expected cash flow.

This provides a much clearer picture of affordability.

Warning Signs That Your Business May Have Too Much Debt

There are several signs that debt may be putting excessive pressure on the business.

You Are Using New Debt to Pay Existing Debt

If the business continually borrows more money to meet existing repayments, investigate the underlying cash-flow problem.

Debt Repayments Are Consuming Too Much Cash

If a large proportion of operating cash is being used to service debt, there may be limited room for unexpected expenses or investment.

You Regularly Struggle to Pay Suppliers

Supplier payment problems can indicate that too much cash is being directed toward other financial commitments.

You Are Constantly Relying on Credit Cards or Overdrafts

Short-term borrowing can become expensive if it is being used to cover recurring operating costs.

Profit Is Increasing, but Cash Is Not

This may indicate that cash is being absorbed by debt repayments, working capital or other commitments.

You Have No Financial Buffer

A business that uses nearly all available cash to meet debt obligations may be vulnerable to a temporary decline in sales or an unexpected expense.

Debt Used for Growth vs Debt Used to Survive

The reason behind the borrowing matters.

Debt Used for Growth

Borrowing may be used to:

• Purchase equipment
• Increase production capacity
• Open another location
• Acquire a business
• Fund additional inventory
• Invest in technology

If the investment is expected to generate sufficient returns, the debt may support long-term growth.

Debt Used to Cover Ongoing Losses

A different situation occurs when borrowing is repeatedly used to:

• Pay wages
• Cover rent
• Pay suppliers
• Cover recurring losses
• Make previous debt repayments

If the underlying business model isn’t generating enough cash, additional debt may only postpone the problem.

How Much Debt Can Your Business Actually Afford?

Instead of starting with a target debt number, work backwards from your cash flow.

Start by identifying:

1. Current operating cash flow
2. Existing debt repayments
3. Expected future cash flow
4. Essential operating expenses
5. Tax obligations
6. Working capital requirements
7. Cash reserves

Then determine how much additional repayment the business could realistically handle.

For example, if your business already has limited free cash flow, taking on another large monthly repayment may create unnecessary risk.

Consider Your Cash Reserves

Debt should be considered alongside your available cash reserves.

A business with substantial cash reserves may have more flexibility than a business with the same debt balance but almost no cash available.

Ask:

• How much cash is currently available?
• How many months of essential expenses could it cover?
• What major payments are coming?
• How stable is revenue?
• What would happen if sales declined temporarily?

This helps put debt into context.

Stress-Test Your Business Debt

Before taking on additional debt, consider what happens if circumstances don’t go according to plan.

For example:

Sales Fall

What happens if revenue falls by 10%?

Customers Pay More Slowly

What happens if customer payments are delayed by 30 days?

Costs Increase

What happens if supplier or operating costs rise?

Interest Rates Increase

What happens if borrowing costs increase?

A Major Customer Leaves

What happens if a significant source of revenue disappears?

If the business can still meet its obligations under reasonable downside scenarios, the debt may be more manageable.

If a relatively small change would cause repayment difficulties, caution may be warranted.

Don’t Ignore Your Working Capital Requirements

Debt affordability is also connected to working capital.

A growing business may need additional cash to fund:

• Inventory
• Receivables
• Payroll
• Supplier payments
• New projects

If all available cash is being used to service debt, the business may have less flexibility to fund normal operations.

This can become particularly important during periods of rapid growth.

Review the Purpose of Every Loan

For each existing debt facility, ask:

What did we borrow this money for?

Then ask:

Is that investment still generating value for the business?

For example, equipment finance may be supporting additional revenue.

A business acquisition loan may relate to a profitable acquisition.

But an old credit facility that is continually used to fund operating shortfalls may require closer examination.

Understanding the purpose of your debt can help you determine whether it is productive, necessary, or potentially becoming a burden.

Should You Pay Off Business Debt Early?

Paying debt off early can reduce interest costs and improve the business’s financial position.

However, using all available cash to eliminate debt isn’t always the best decision.

Before making a large repayment, consider:

• Cash reserves
• Upcoming expenses
• Tax obligations
• Working capital needs
• Investment opportunities
• Loan terms
• Early repayment costs

A business needs enough liquidity to continue operating comfortably.

Reducing debt while leaving the business without adequate cash could create a different financial problem.

How Can a Business Reduce Its Debt?

If debt is putting pressure on your business, possible strategies may include:

• Reducing unnecessary expenses
• Improving customer collections
• Reviewing pricing
• Increasing profitable sales
• Selling underutilised assets
• Refinancing where appropriate
• Negotiating repayment arrangements
• Reducing discretionary spending
• Reviewing working capital
• Avoiding unnecessary new borrowing

The appropriate approach depends on the business’s financial position.

How Can an Accountant Help You Assess Business Debt?

Debt decisions shouldn’t be based on the loan amount alone.

An accountant or business adviser can help you analyse:

• Cash flow
• Profitability
• Debt servicing capacity
• Working capital
• Debt-to-equity
• Financial forecasts
• Business assets
• Future growth plans

At Latitude Accountants, we help Australian business owners understand their financial position and make informed decisions about business growth, cash flow and financial commitments.

The goal isn’t necessarily to eliminate all debt.

It’s to ensure your debt is appropriate for the business and manageable within its financial capacity.

Frequently Asked Questions About Business Debt

How much debt is too much for a small business?

There is no universal debt limit for every small business. Debt becomes concerning when the business cannot comfortably meet repayments while still covering operating expenses, tax obligations and working capital requirements.

Is business debt always bad?

No. Debt can help fund productive investments such as equipment, expansion or acquisitions. The key is whether the borrowing is affordable and likely to support the business’s financial objectives.

What is a good debt-to-equity ratio for a small business?

There is no single ratio that is appropriate for every business. The right level depends on the industry, business model, profitability, assets, cash flow and risk profile.

How do I know if my business can afford another loan?

Review your current cash flow, existing debt repayments, operating expenses, tax obligations and working capital requirements. A cash-flow forecast can help model the impact of additional repayments.

Can a profitable business have too much debt?

Yes. A business can report a profit while having insufficient cash to comfortably service its debt. Cash flow and repayment capacity need to be considered alongside profitability.

Should I pay off my business debt as quickly as possible?

Not necessarily. Paying debt down can reduce interest costs, but maintaining sufficient cash reserves and working capital is also important. The right approach depends on the business’s circumstances.

What are the warning signs of excessive business debt?

Warning signs can include regularly missing or struggling with payments, relying on new borrowing to repay existing debt, limited cash reserves, increasing interest costs, and insufficient cash flow to cover debt obligations comfortably.

Talk to Latitude Accountants About Your Business Debt

Business debt can be a useful tool when it is structured appropriately and supported by sufficient cash flow.

The important question isn’t simply how much your business owes.

It’s whether the business can comfortably manage those obligations while continuing to operate, invest and grow.

Latitude Accountants provides accounting, budgeting, forecasting, tax planning and business advisory services to help Australian business owners understand their numbers and make informed financial decisions.

If you’re considering additional borrowing, concerned about existing debt or want to understand your business’s debt capacity, our team can help you assess the numbers.

Latitude Accountants

📍 Sydney Olympic Park | Marrickville | Melbourne | Loxton
📞 1300 706 597
📧 info@latitudeaccountants.com.au

Want tailored business advice? Let’s chat.

Disclaimer

This article provides general information only and does not constitute financial, tax, accounting, lending or business advice. Debt capacity and appropriate borrowing levels vary depending on the business’s financial position, structure, industry, cash flow and individual circumstances. Financial ratios and examples provided are for general educational purposes and should not be treated as specific recommendations. You should seek advice from appropriately qualified professionals before making borrowing, refinancing or other financial decisions.