Here's what to look for in a company's balance sheet.
Q: I know that most companies use debt to help fund their operations, but how can I tell if a company's debt load is too high?
Unfortunately, there's no universal rule about how much is too much when it comes to debt, but here are three metrics that can help.
First, the debt-to-EBITDA ratio is a great metric for comparing a company's debt with others in the same industry. You can calculate this by taking a company's total debt from its balance sheet and dividing by its EBITDA, which can be found on the income statement. Normal debt levels can vary, but a debt-to-EBITDA ratio above the 4-5 range is typically considered high.
One major shortcoming of the debt-to-EBITDA ratio is that it doesn't consider the amount of interest the company is paying. Rock-solid companies can borrow money at significantly cheaper costs than those without stellar credit ratings. So the second metric you can use is the company's interest coverage, which is the ratio of its net income to the amount of interest it pays on its debt obligations. Again, this is most useful for comparing companies within the same industry.
Finally, it's important to considernet debt, not just the debt figures listed on a company's balance sheet. For example, Applehas nearly $100 billion in debt, but also has about $210 billion in cash on its balance sheet, so to simply say, "Apple has $100 billion in debt" is a bit misleading. Apple's net debt is actually negative, meaning that it could pay off all of its debt and have cash left over -- and lots of it.
None of these tells the full story of a company's debt situation all by itself. However, knowing these three metrics can help put a company's debt load in proper perspective when you're analyzing a stock.
Matthew Frankel, CFP owns shares of AAPL. The Motley Fool owns shares of and recommends AAPL. The Motley Fool has the following options: short January 2020 $155 calls on AAPL and long January 2020 $150 calls on AAPL. The Motley Fool has a disclosure policy.
FAQs
In general, many investors look for a company to have a debt ratio between 0.3 and 0.6. From a pure risk perspective, debt ratios of 0.4 or lower are considered better, while a debt ratio of 0.6 or higher makes it more difficult to borrow money.
How to calculate if a company has too much debt? ›
A company's debt ratio can be calculated by dividing total debt by total assets. A debt ratio of greater than 1.0 or 100% means a company has more debt than assets while a debt ratio of less than 100% indicates that a company has more assets than debt.
How much debt is too much debt? ›
Generally speaking, a good debt-to-income ratio is anything less than or equal to 36%. Meanwhile, any ratio above 43% is considered too high. The biggest piece of your DTI ratio pie is bound to be your monthly mortgage payment.
What percentage of debt should a company have? ›
As a general rule, you shouldn't have more than 30% of your business capital in credit debt; exceeding this percentage tells lenders you may be not profitable or responsible with your money. Plus, relying on loans for one-third of your operating money can lower your business credit score significantly.
What companies are in the most debt? ›
Toyota holds the title of the world's most indebted company outside the financial industries, with a debt of $221.13 billion. Amazon ($138.91 B) and Apple ($109.28 B) top the list of the world's most indebted tech companies.
How can I pay off 35000 in debt? ›
It will take effort, discipline and, perhaps, some outside help, but you can make it if you do the following:
- Make a list of all your credit card debts.
- Make a budget.
- Create a strategy to pay down debt.
- Pay more than your minimum payment whenever possible.
- Set goals and timeline for repayment.
- Consolidate your debt.
The debt-to-capitalization ratio measures the amount of debt a company uses to finance its assets compared to the amount of equity used to finance its assets. A high debt-to-capitalization ratio could indicate that a company has a higher risk of insolvency due to being over-leveraged.
What is the quickest way to determine whether the firm has too much debt? ›
The Debt-to-EBITDA measure is the most common cash flow metric to evaluate debt capacity. The ratio demonstrates a company's ability to pay off its incurred debt and provides investment bankers with information on the amount of time required to clear all debt, ignoring interest, taxes, depreciation, and amortization.
What happens when a company has too much debt? ›
Meaning that if a company cannot pay back its debt, banks are able to take ownership of a company's assets to eventually liquidate them for cash and settle the outstanding debt. In this manner, a company can lose many if not all of its assets.
How much debt is the average American in? ›
The average debt an American owes is $104,215 across mortgage loans, home equity lines of credit, auto loans, credit card debt, student loan debt, and other debts like personal loans. Data from Experian breaks down the average debt a consumer holds based on type, age, credit score, and state.
According to the 28/36 rule, you should spend no more than 28% of your gross monthly income on housing and no more than 36% on all debts. Housing costs can include: Your monthly mortgage payment. Homeowners Insurance. Private mortgage insurance.
What is the 50 30 20 rule? ›
The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings. The savings category also includes money you will need to realize your future goals.
How much debt does Tesla have? ›
Total debt on the balance sheet as of March 2024 : $9.91 B
According to Tesla's latest financial reports the company's total debt is $9.91 B. A company's total debt is the sum of all current and non-current debts.
Should I pay off business debt? ›
The key to deciding what's best for your business is to do the math. Figure out how much you could save on interest if you settled early and then subtract any fees that might be assessed. If the result is positive, you may want to pay off your loan whereas you might want to hold off if it's negative.
How much debt does the average company have? ›
According to the result of a survey conducted in 2022, 16 percent of small- and medium-sized companies in the United States had debt outstanding between 250,000 U.S. dollars and a million U.S. dollars. Meanwhile, 28 percent of SMEs reported having no outstanding debt.
How much debt does the average business owner have? ›
The average small business owner today has nearly $200,000 in debt. While financial leverage is often an essential way to grow a small or medium-sized business, you need to be careful about how much debt you take on.
