Small Business Debt Management: 6 Numbers to Track Every Month

If you’ve taken on debt to get a business off the ground, but debt service is getting in the way of profitable growth, you don’t need a new accounting system. You need six numbers, checked every month: debt payments as a share of gross revenue, debt service coverage ratio (DSCR), debt-to-revenue, debt-to-equity, current ratio, and what each individual debt really costs. It doesn’t matter how much profit you’re making if you can’t service your debt. Look at these numbers alongside your P&L and cash flow statement.

Unmanaged debt drains cash as payments eat operating capital. Credit scores drop, lenders may tighten terms or call loans if covenants are breached. And Forbes calculates that roughly 29% of small businesses fail when the cash runs out.

Before you even start, build a master list of every debt - lenders, original balances, current balances, interest rates or factor rates, monthly payments, maturity dates, secured or unsecured - and keep it up to date each month. You’d be surprised how many owners owe more than they realized.

Debt Number to Track

The first number to track is debt payments as a share of gross revenue. What percentage of every dollar you make are going to debt payments? Total all debt payments each month and divide by gross revenue. Are you spending 20%, 30%, 50% or more of your revenue on debt service? The lower, the better. Many advisors suggest keeping debt service under 20% or 25%. Above 30%, debt typically squeezes cash flow, leaving little for operations, hiring or surprises.

The second number to check monthly is your debt service coverage ratio (DSCR). DSCR is annual net operating income divided by annual debt service, or the sum of all debt payments. A DSCR of 1.0 means a business makes just enough to cover monthly debt payments; 1.25 is the minimum required by most lenders. Ideally, 1.5 or higher. Anything under 1.0 is an immediate concern. Don’t check it only when applying for a loan.

A dental practice owner saw her DSCR fall from 1.4 to 1.1 over three months. Adding a new associate who hadn’t yet generated revenue increased the overhead. She reworked the associate’s pay with a performance bonus to ease the overhead hit. Recovery came within two quarters, before any lender noticed the slip.

The third number to check: debt-to-revenue, or total outstanding debt divided by annual revenue. Below 50% is generally healthy; between 50% and 100% can be manageable, but keep an eye on it. Above 100% represents elevated risk that may limit new financing. The fourth is debt-to-equity. Total liabilities over owner’s equity reveals leverage levels. Below 2.0 is typically manageable; higher means the business is heavily leveraged.

The fifth key debt metric: the current ratio, or current assets divided by current liabilities, shows if a business can cover short-term obligations with liquid assets. A healthy ratio is above 1.5, meaning assets can cover obligations 1.5 times. Anything below 1.0 can mean a business may need to borrow just to pay near-term bills.

The final debt number to track: the real cost of each debt. Interest rates and factor rates just scratch the surface. Merchant cash advances work on factor rates, not interest. The effective APR on term loans typically ranges from 6% to 25%, while MCA factor rates often equal 20% to 50% of the advance. MCA APRs can run from 40% to over 200%. Paying off your most expensive debt first saves money in the long run.

Think of your various loans, advances and credit lines as individual investments that you made. Which investments are paying off, and which are hurting you? Good debt earns more than it costs. Borrowing $100,000 at 8% for equipment that adds $30,000 a year in profit is good debt. Borrowing at 40% to cover payroll for a team bringing in no new revenue is bad debt. MCAs also pull daily or weekly debits tied to sales, which can hurt in slow periods.

Identify Opportunities to Reduce the Burden

Once you have visibility on your debt situation, you can identify opportunities to reduce the burden. For example, a restaurant owner had three stacked merchant cash advances, totaling $180,000 outstanding. She consolidated into one $200,000 term loan at a far lower rate, with a fixed payment of $4,800 a month. Her cash flow turned positive within 60 days.

You know it’s time to act when you borrow one loan to pay off another. When you hit up a credit line to make payroll. When debt grows faster than revenue. When lenders cut credit lines or decline renewals. Payroll should come from operating revenue, not debt. And be careful with payroll taxes: an owner or other responsible person who willfully fails to pay over withheld payroll taxes can be held personally liable for 100% of the unpaid trust fund taxes (IRS Trust Fund Recovery Penalty).

If you see a payment you can’t make coming up, contact the lender before it is due. A missed payment can bring late fees, a default notice, damaged credit, and in some cases, acceleration clauses making the entire balance due immediately. Many lenders work with borrowers who call early, arranging deferments or temporary hardship arrangements.

Before you refinance or consolidate, compare the total interest costs across both time frames. An extended term can lower payments but raise total interest. The new debt must cost less than what it replaces. Borrowing to postpone problems usually makes them worse.

Few ideas keep cash safer from unforeseen disasters than a debt service reserve. Each month, deposit a fixed percentage of revenue into a separate bank account. Save until it can cover three to six months of debt service. If a slow season or lost client pulls revenue, this fund covers debt service until business returns.

If you owe, you need to know. Track the six numbers every month alongside the P&L and cash flow statement. Review refinancing or consolidation options once a quarter to see if you can free up cash or lower monthly payments. Take a fresh look anytime a big swing in revenue or a new borrowing need hits. Start by knowing exactly what you owe, what it costs and where you stand.