You’re taking on debt.
You’re not sure if it’s too much. You’re not sure if it’s the right type.
You’re guessing. You’re hoping. You’re worried.
Poor debt management kills businesses.
Too much debt crushes cash flow. Wrong types of debt create risk. Unmanaged debt leads to failure.
This guide shows you how to manage debt.
Assess debt health. Understand debt ratios. Manage debt strategically.
Key Takeaways
- Debt health is measured by debt ratios—Debt Service Coverage Ratio and Debt-Equity Ratio show if debt is manageable
- Healthy businesses have DSCR above 1.25 and Debt-Equity Ratio below 2.0—above these indicates financial stress
- Use Debt Service Coverage Ratio Calculator and Debt-Equity Ratio Calculator to assess your debt health
- Manage debt by monitoring ratios monthly, reducing high-cost debt, refinancing strategically, and maintaining healthy ratios
- Different debt types serve different purposes—match debt type to business need and avoid taking wrong types of debt
Table of Contents
Why Debt Management Matters
Debt management determines survival.
Without debt management:
- You take on too much debt
- You choose wrong types of debt
- Cash flow suffers
- Financial stress increases
- Business failure risk rises
With debt management:
- You take on appropriate debt
- You choose right types of debt
- Cash flow remains healthy
- Financial stress is controlled
- Business operates securely
The reality: Poor debt management kills 30% of businesses that fail.
Most businesses don’t manage debt strategically. They borrow. They hope it works.
The truth: Debt management is measurable. Assess it. Monitor it. Control it.
Understanding Debt Health
Debt health is your ability to manage debt.
Healthy debt:
- Manageable payments
- Supports growth
- Improves cash flow
- Low risk
Unhealthy debt:
- Unmanageable payments
- Hinders growth
- Hurts cash flow
- High risk
The question: Is your debt healthy?
The answer: Calculate debt ratios.
Calculating Debt Ratios
Calculate debt health using two key ratios.
Ratio 1: Debt Service Coverage Ratio (DSCR)
DSCR measures your ability to pay debt.
The formula:
- DSCR = Net Operating Income / Total Debt Service
What it shows:
- Above 1.25 = Healthy debt service
- 1.0 to 1.25 = Adequate debt service
- Below 1.0 = Cannot pay debt (financial distress)
Calculate it: Use the Debt Service Coverage Ratio Calculator to find your DSCR.
Example:
- Net Operating Income: $100,000
- Total Debt Service: $75,000
- DSCR = $100,000 / $75,000 = 1.33
You can pay debt 1.33 times over. Healthy debt service.
Ratio 2: Debt-Equity Ratio
Debt-Equity Ratio measures leverage.
The formula:
- Debt-Equity Ratio = Total Debt / Total Equity
What it shows:
- Below 1.0 = Low leverage (conservative)
- 1.0 to 2.0 = Moderate leverage (healthy)
- Above 2.0 = High leverage (risky)
Calculate it: Use the Debt-Equity Ratio Calculator to find your debt-equity ratio.
Example:
- Total Debt: $200,000
- Total Equity: $150,000
- Debt-Equity Ratio = $200,000 / $150,000 = 1.33
You have $1.33 in debt for every $1 in equity. Moderate leverage.
Types of Debt
Different debt types serve different purposes.
Type 1: Short-Term Debt
Debt due within one year.
Common examples:
- Lines of credit
- Credit cards
- Short-term loans
- Accounts payable
Best for:
- Working capital
- Cash flow gaps
- Seasonal needs
- Short-term opportunities
Risks:
- Higher interest rates
- Frequent payments
- Cash flow pressure
- Renewal risk
Type 2: Long-Term Debt
Debt due after one year.
Common examples:
- Term loans
- Equipment financing
- Real estate loans
- SBA loans
Best for:
- Capital investments
- Equipment purchases
- Real estate
- Growth financing
Risks:
- Collateral requirements
- Longer commitment
- Fixed payments
- Prepayment penalties
Type 3: Secured Debt
Debt backed by collateral.
Common examples:
- Equipment loans
- Real estate mortgages
- Asset-based loans
Benefits:
- Lower interest rates
- Higher loan amounts
- Longer terms
Risks:
- Collateral at risk
- Asset seizure if default
- Limited flexibility
Type 4: Unsecured Debt
Debt not backed by collateral.
Common examples:
- Credit cards
- Lines of credit
- Personal guarantees
Benefits:
- No collateral required
- Faster approval
- More flexibility
Risks:
- Higher interest rates
- Lower loan amounts
- Personal liability
- Stricter terms
Debt Management Strategies
Manage debt strategically.
Strategy 1: Monitor Debt Ratios
Monitor debt ratios monthly.
Monitor:
- DSCR (target: above 1.25)
- Debt-Equity Ratio (target: below 2.0)
- Debt trends over time
- Payment capacity
Use the Debt Service Coverage Ratio Calculator and Debt-Equity Ratio Calculator monthly.
Strategy 2: Reduce High-Cost Debt
Pay down high-cost debt first.
High-cost debt:
- Credit cards (15-25% APR)
- Unsecured loans (10-20% APR)
- High-interest term loans
Impact: Lower interest costs. Improved cash flow.
Strategy 3: Refinance Strategically
Refinance to better terms.
When to refinance:
- Interest rates drop
- Credit improves
- Better terms available
- Consolidate debt
Use the Loan Repayment Calculator to compare loan options.
Strategy 4: Match Debt to Need
Match debt type to business need.
Matching:
- Short-term needs → Short-term debt
- Long-term investments → Long-term debt
- Working capital → Lines of credit
- Equipment → Equipment financing
Result: Optimal debt structure.
Strategy 5: Maintain Healthy Ratios
Keep debt ratios in healthy ranges.
Healthy targets:
- DSCR: Above 1.25
- Debt-Equity Ratio: Below 2.0
- Debt-to-Assets: Below 0.6
Monitor monthly. Adjust as needed.
Debt Management Framework
Use this framework to manage debt.
Step 1: Calculate Current Ratios
Calculate debt ratios monthly.
Calculate:
- DSCR using Debt Service Coverage Ratio Calculator
- Debt-Equity Ratio using Debt-Equity Ratio Calculator
Step 2: Compare to Benchmarks
Compare ratios to healthy benchmarks.
Healthy benchmarks:
- DSCR: Above 1.25
- Debt-Equity Ratio: Below 2.0
If ratios are unhealthy, take action.
Step 3: Identify Problem Debt
Identify debt that’s causing problems.
Problem debt indicators:
- High interest rates
- Unmanageable payments
- Wrong debt type for need
- DSCR below 1.0
Step 4: Develop Strategy
Develop debt management strategy.
Strategy options:
- Pay down high-cost debt
- Refinance to better terms
- Consolidate debt
- Restructure debt
Step 5: Implement and Monitor
Implement strategy and monitor results.
Monitor:
- Ratio improvements
- Cash flow impact
- Payment capacity
- Risk reduction
Your Next Steps
Stop guessing about debt. Start managing it.
This week:
- Calculate your DSCR using the Debt Service Coverage Ratio Calculator
- Calculate your Debt-Equity Ratio using the Debt-Equity Ratio Calculator
- Compare to healthy benchmarks
- Identify problem debt
This month:
- Develop debt management strategy
- Pay down high-cost debt
- Refinance if beneficial
- Monitor ratio improvements
Ongoing:
- Calculate ratios monthly
- Track trends over time
- Adjust strategy as needed
- Maintain healthy ratios
Remember: Debt management determines survival. Assess it. Monitor it. Control it.
Key Takeaways Recap
- Debt health is measured by debt ratios—Debt Service Coverage Ratio and Debt-Equity Ratio show if debt is manageable
- Healthy businesses have DSCR above 1.25 and Debt-Equity Ratio below 2.0—above these indicates financial stress
- Use Debt Service Coverage Ratio Calculator and Debt-Equity Ratio Calculator to assess your debt health
- Manage debt by monitoring ratios monthly, reducing high-cost debt, refinancing strategically, and maintaining healthy ratios
- Different debt types serve different purposes—match debt type to business need and avoid taking wrong types of debt
Related Tools and Resources
Debt Management Calculators
- Debt Service Coverage Ratio Calculator - Measure ability to pay debt
- Debt-Equity Ratio Calculator - Assess leverage
- Loan Repayment Calculator - Compare loan options
Financial Health Tools
- Current Ratio Calculator - Measure liquidity
- Working Capital Calculator - Manage working capital
- Cash Flow Forecast Calculator - Project cash flow
Need help managing your business filings and registrations? Contact Business Initiative to get your company registered and in good standing with the states.
FAQs - Frequently Asked Questions About Poor Debt Management: Taking On Too Much Debt or Wrong Types of Debt
What are the two key ratios that reveal whether your business debt is healthy or dangerous?
Debt Service Coverage Ratio (DSCR) measures your ability to pay debt, and Debt-Equity Ratio measures your leverage level.
Learn More...
DSCR is calculated by dividing Net Operating Income by Total Debt Service. Above 1.25 is healthy, 1.0 to 1.25 is adequate, and below 1.0 means you can't cover your debt payments.
Debt-Equity Ratio is calculated by dividing Total Debt by Total Equity. Below 1.0 is conservative, 1.0 to 2.0 is moderate and healthy, and above 2.0 signals high leverage and increased risk.
Together, these ratios give you a clear picture of debt health—DSCR shows whether you can make payments, and Debt-Equity Ratio shows whether you're overleveraged relative to your equity.
Monitor both ratios monthly to catch deterioration early before it becomes a financial crisis.
How do you know if you're taking on the wrong type of debt for your business needs?
Debt is wrong when it doesn't match the need—using short-term debt for long-term investments or high-interest unsecured debt when secured options are available.
Learn More...
Short-term debt like credit cards and lines of credit should fund working capital and seasonal cash flow gaps, not long-term capital investments.
Long-term debt like term loans, equipment financing, and SBA loans are designed for capital investments, equipment purchases, and growth financing.
Secured debt offers lower interest rates and higher amounts but puts your assets at risk, while unsecured debt is faster and more flexible but costs more.
The rule is simple: match debt type to business need. Short-term needs get short-term debt, long-term investments get long-term debt, and working capital uses lines of credit.
What DSCR level signals that your business is in financial distress from too much debt?
A DSCR below 1.0 means your operating income cannot cover your debt payments—you're in financial distress.
Learn More...
A DSCR below 1.0 literally means you don't generate enough operating income to make your debt payments, requiring you to tap reserves, take on more debt, or default.
A DSCR of 1.0 to 1.25 is a warning zone—you can technically make payments but have no margin for error, and any revenue dip could push you into distress.
Healthy businesses maintain DSCR above 1.25, meaning they can cover debt payments with 25% or more to spare.
For example, if your Net Operating Income is $100,000 and your Total Debt Service is $75,000, your DSCR is 1.33—healthy, with room to absorb revenue fluctuations.
What are the five key strategies for managing business debt before it becomes a problem?
Monitor ratios monthly, reduce high-cost debt first, refinance to better terms, match debt types to needs, and maintain healthy ratio targets.
Learn More...
Strategy 1: Monitor DSCR and Debt-Equity Ratio monthly to track your debt health trajectory and catch problems early.
Strategy 2: Pay down high-cost debt first—credit cards at 15-25% APR and unsecured loans at 10-20% APR drain cash flow the fastest.
Strategy 3: Refinance strategically when interest rates drop, your credit improves, or better terms become available to reduce your debt service costs.
Strategy 4: Match debt to need so you're not paying short-term interest rates on long-term investments or locking into long-term commitments for temporary needs.
Strategy 5: Maintain healthy targets—DSCR above 1.25, Debt-Equity Ratio below 2.0, and Debt-to-Assets below 0.6.
How does poor debt management contribute to business failure?
Too much debt crushes cash flow, wrong debt types create unnecessary costs, and unmanaged debt leads to inability to pay obligations.
Learn More...
Poor debt management kills an estimated 30% of businesses that fail, making it one of the leading causes of business death.
Excessive debt creates a cash flow squeeze—high monthly payments leave insufficient cash for operations, payroll, inventory, and growth investments.
Wrong debt types compound the problem: using high-interest credit cards for long-term capital needs means paying double or triple the interest versus a term loan.
Without monitoring debt ratios, businesses often don't realize they're overleveraged until a revenue dip makes payments impossible, at which point options are limited and expensive.
When should you refinance business debt and how do you evaluate whether refinancing is worthwhile?
Refinance when interest rates drop, your creditworthiness improves, or you can consolidate multiple debts into better terms.
Learn More...
Refinancing makes sense when market interest rates have dropped significantly below your current rates, potentially saving thousands in interest costs.
If your business credit profile has improved since you took on debt (higher revenue, better payment history, more assets), you may qualify for substantially better terms.
Debt consolidation through refinancing simplifies management by replacing multiple payments with one, often at a lower blended interest rate.
Use a Loan Repayment Calculator to compare your current debt terms against refinancing options—factor in any prepayment penalties, origination fees, and the total cost over the remaining loan life, not just the monthly payment.
