12
Friday
July 2024
How much debt is justified?
Summer is in full swing, but the weather leaves something to be desired. Vendors of ice cream and BBQ packages are stuck with hefty inventories, while farmers cannot get out on the land to farm and sow. What a difference from the drought of previous years. Sectors where weather has a major impact are therefore also more vulnerable than sectors where this impact is lower. Each sector has its own risk factors to consider when determining a responsible debt level.
But what is responsible debt? Unfortunately, this is not easy to determine because it varies by company, size and sector.
Payment capacity
At WDL Credit Funds, we determine the level of debt to be accounted for on a daily basis for SME entrepreneurs. This starts with determining a company’s payment capacity (Debt Service Capacity). For this, we use a ratio within the financial sector: the Debt Service Coverage Ratio (DSCR). This ratio indicates whether a company meets the minimum requirements by dividing free cash flow by financial liabilities. This ratio must obviously be higher than 1. Depending on the assessed risks within the company or sector, a DSCR of 1.2 or higher is often assumed. For an ice cream factory, for example, this ratio is higher than for a metal processing company.
Finances in view
Visualizing annual financial obligations (interest and repayments) is usually still doable. Determining free cash flow is already getting a little trickier. And then what is an acceptable ratio (DSCR)? This requires specialized knowledge and a great deal of financing experience. It does not always fall flat with just an LTV (loan to value collateral).
The help of specialists
A good debt structure is customized. What works for one company may be disastrous for another. This is why at WDL we look not only at the numbers, but also at a company’s specific context and risks.
Tips for SMEs
- Know your numbers: Make sure you know exactly what your income and expenses are and keep a close eye on your cash flows.
- Be realistic: Consider what you can really pay back, even in down times.
- Enlist help: Get advice from someone experienced in corporate finance.
- Diversify your risk: Make sure you are not dependent on a single revenue source or market.
Even in this wet summer, we are ready to spar about financing solutions. For everyone else, happy vacations!
Financing solution?
At our office in Veghel it is dry and the coffee is ready, call Maykel Hermanussen at 06 57 26 38 44 for an appointment.
Or mail Maykel
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