Debt Ratio – SBA’s Definition of a Small Business & Large Business

Dear M & M: 

I hear so much about the debt ratio but have no idea what it is.

Thanks,

-Gilbert

 

Dear Gilbert: 

Investors generally consider a business’ debt ratio an indication of the stability of the business and whether its stock is a suitable investment. Often referred to as the debt-to-equity ratio, this ratio measures the amount of debt a company takes on to finance its operations vs. its amount of available capital. Determining a good debt ratio isn’t easy.

Calculations – Calculating the debt-to-equity ratio is simply a matter of taking the amount of money a company uses to finance its operations and dividing that by the total available capital. For example, a business that has accumulated $50 million in debt and has $150 million in assets has $200 million in available capital. The debt ratio in this example will be .25 or 25 percent ($50 million divided by $200 million equals .25). The higher the calculated percentage, the more a business relies upon borrowed funds.

Good Debt – Businesses take on debt even when they have assets that could pay for their expenses when they know they can get a better rate of return on the borrowed money than what they are paying out in interest. The leverage the borrowed funds create allows investors to have a greater amount of return on their money. Therefore, not all debt is necessarily bad debt. However, too much debt can be a sign of instability. In some cases, a debt ratio of less than 1 means greater stability. Whenever the ratio exceeds this figure, it indicates a heavily reliance upon debt for continued operations.

Bad Debt – Having a debt ratio higher than 1 does not necessarily mean a company has too much debt or has made bad financial decisions. Instead, it simply means that it relies more heavily on the debt than do other companies with a lower debt ratio. According to the Finance Owl, a higher debt ratio can be interpreted as a higher risk for investors, but it can also have a higher amount of leverage, especially since some interest payments can be written off on tax statements.

Assessment – Because there is no hard and fast rule about what is considered a good debt ratio vs. a bad debt ratio, investors should always seek professional consultation whenever possible before making any investment decisions. According to the website Stocks-Simplified.com, debt ratios tend to differ from one industry to the next. Therefore, wise investors often compare the debt ratio of one company to another in the same industry to determine whether the debt ratio should be judged as either good or bad.

 -M&M

Dear M & M:

What does the Small Business Administration go by to calculate or differentiate a small business from a large business?

–Rebecca

 

Dear Rebecca:

Small business size standards are numerical definitions of what constitutes a small business. A business concern is small if it is at or below a size standard. If a business concern is small it is eligible for Federal government programs reserved for small business concerns. Size standards have been established for types of economic activity, or industry, as defined under the North American Industry Classification System (NAICS). The most size standards are defined based on either average number of employees over the past 12 months or average annual revenues over the past three years. The most common standards are as follows: $0.75 million for most agricultural industries, $33.5 million for heavy construction industries, $14.0 million for specialty trade contractors, 500 employees for most manufacturing and mining industries, 100 employees for all wholesale trade industries, $7.0 million for most retail and service industries, (For complete list of size standards, see the SBA’s Table of Small Business Size Standards). http://www.sba.gov/content/small-business-size-standards

 -M&M

To ask your questions: Call the Small Business Development Center(SBDC) at Cochise College (520)-515-5478 or email schmittm@cochise.edu or contact the Sierra Vista Economic Development Foundation(EDF) at 520-458-6948 or email  hollism@svedf.org

 

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