Anyone who manages a company or works in the financial sector of a business needs to pay attention to the company’s level of debt. This indicator provides important information about the company’s finances and the corporate budget.
However, determining whether a company is in debt is not a simple task. To be able to visualize this situation, it is necessary to understand what debt is, what the risks of this scenario are and the financial signs on the subject.
Do you want to learn how to assess your company’s debt and find out 3 signs that your business is in debt? Then check out this complete content!
What are the risks of having a high debt ratio in the business?
You have noticed that a high level of debt in the company can lead to default. This scenario results in the payment of interest on arrears and late payment fines.
Therefore, high debt should be a warning sign for the business. If the company does not have the financial means to meet all the obligations that are due, there will be serious problems.
However, even when debt does not lead to default, it can bring other worrying consequences.
When the indicator is too high, the company’s profitability also falls. After all, part of the business’s revenue will be used to pay off debts. Imagine that your company had revenue of R$50,000 in a quarter. However, debts amount to R$30,000. In this case, the financial surplus was only R$20,000.
Signs of debt in your business
As you have seen, a high level of debt can have negative consequences for your company. Therefore, it is worth paying attention to the signs that this indicator may be out of control.
Check out 3 ways to observe this situation in your business below:
1. High EG index
It serves to illustrate the percentage of the business’s assets that are financed by outside sources. In other words, given the existence of a credit relationship, which of all the assets result in debt?
To arrive at this index result, the company must have some information at hand. One of them is the total assets of the business, adding up all cash, inventory, machinery, investments, etc.
Third-party capital is another crucial piece of information. Stated differently, assets pertaining to business partners. Loans, finance, and other contracted lines of credit are among the most prevalent.
Once you have this information, simply apply the following formula:
EG Index = (Debt capital / Company assets) x 100
Imagine that your company has total assets equal to R$200,000. In relation to third-party capital, it represents R$50,000. In this case, the EG ratio will be equal to 25%, meaning that a quarter of the company’s assets belong to obligations with third parties.
In practice, the lower this index, the lower your company’s debt. Therefore, it is worth using the indicator regularly to monitor the evolution of the number.
2. Many bills to pay in the short term
Another warning sign is the debt term: high amounts owed in the short term can lead to payment difficulties. In this case, an index that can be monitored by the company is the debt composition, or CE.
It is related to the company’s debt term, according to the dates for fulfilling obligations. To perform the calculation, you need to have access to the amount of short-term and long-term liabilities. Then, simply apply the formula:
CE Ratio = (Short-term liabilities / Long-term liabilities) x 100
For example: if your company’s short-term liabilities amount to R$10,000 and its long-term liabilities amount to R$8,000, the CE ratio will be 125%. This could be a warning sign for the company regarding the need for resources and liquidity to pay off its debts.
3. Lack of financial planning
Finally, it is also possible to check for signs of debt through the business’s financial routine. One of the main points of attention in this context is the lack of control and specialized financial planning in the company.
When there is no planning, managers will not have a broad view of the business’s finances. As a result, they may make mistakes when calculating working capital and using third-party resources to maintain the business.
Over time, the debt rate can increase considerably, especially in times of crisis. As a result, the company may become in default and have to bear unnecessary costs.
Now you know 3 signs of debt in a company. So, it is worth setting up a routine to monitor debt levels and always have good financial planning to avoid default and falling profits.
