How can you determine if a company has too much debt?
Debt is a common and often necessary source of financing for businesses, but too much of it can pose serious risks. Excessive debt can limit a company's flexibility, increase its interest expenses, and reduce its profitability and cash flow. It can also make a company more vulnerable to economic downturns, competitive pressures, and credit rating downgrades. How can you determine if a company has too much debt? Here are some useful tools and ratios to help you assess a company's debt situation.
-
Debt-to-EBITDA ratio:This metric offers insights into how many years it would take a company to pay off its debt using its earnings before interest, taxes, depreciation, and amortization. It's especially helpful in comparing companies within the same industry.
-
Interest coverage ratio:This ratio reveals how comfortably a company can pay its interest expenses from its earnings. A higher number suggests stronger solvency and profitability, serving as a quick health check on a companyâs financial stress levels.