Page 93 - BCM_April_2024

ACCOUNTING

All About Business Debt

The good, the bad and the otherwise of an important tool for growth.

ne of the most daunting four-letter words for any borrows, the more it must spend for debt payments and
O bowling center owner — particularly those with interest.
smaller businesses — is “debt.” Today’s tight credit market But how much debt is too much? Lenders love to analyze
and the general skittishness on the part of lenders have ratios. It allows them to see how a business is doing and
made avoiding debt easier for many owners. compare it to other businesses they’ve loaned money to.
But what about those debts they can obtain, Ratio analysis also is a useful tool for the owner of a bowling
bad debts and debt forgiveness? center.
A bowling center typically has two nan- How healthy is your center? Some basic ratio analysis
cial resources for growth: debt or equity. may tell the story. Calculating the operation’s nancial
Raising equity requires the business to sell ratios will enable any operator to check their business’s
MARK E. ownership interests, while debt enables the current temperature, diagnose potential problems and see
BATTERSBY business to obtain the funds needed to grow if the center is doing better or worse over time.
and operate by borrowing it. In other words, Consider the so-called “Total Debt Ratio.” e name of
debt can be extremely advantageous and a this ratio says it all; it shows how much the business is in
useful tool for any bowling center business. debt, making it an excellent way to check the operation’s
At the other end of borrowing, for a troubled bowling long-term solvency. e formula is: Total Debt Ratio = Total
center, forgiveness of a debt generally produces taxable Debt/Total Assets.
income. ere are exceptions to the requirement for ese numbers can be taken from the operation’s bal-
reporting debt foregiveness as income, such as insolvency ance sheet and simply plugged in. To illustrate, a business
or for those operating increasingly popular LLCs that hold with $22,375 in total assets and $25,000 in total debt would
a unique position under our have a Total Debt Ratio of
tax lawas. LLCs are gener- $25,000/$22,375 = 1.11:1.
ally treated as a pass-through us, this business has $1.11
entity (unless there’s only one Incurring any type of debt in debt for every dollar of assets.
member, in which case the usually has tax consequences.. Obviously, the Total Debt Ratio
entity is disregarded and taxes reveals this business is not in
included on Schedule C of the In most cases, borrowed good health and may become
individual’s Form 1040). funds — the defi nition of debt really iill. For good health, the
Not too surprisingly, incur- — result in a tax deduction. total debt ratio should be 1 or
ring any type of debt usually less.
has tax consequences. In most e lower the debt ratio, the
cases, borrowed funds, or debt, less total debt the business has
result in a tax deduction. at means the interest portion of in comparison to its asset base. Businesses with high total
the loan repayments can be deducted on the operation’s tax debt ratios are in danger of becoming insolvent and/or go-
returns. ing bankrupt.
Tax deductions also have an impact on interest rates. If, While a bowling center operator may nd the prospect of
for instance, a lender is charging 10 percent for a loan, and becoming debt-free intimidating, the evidence shows that
the government taxes the operation at a 30% rate, there is an during economic downturns, the less debt a business has,
advantage to tax-deductible loans. the greater the odds of that business surviving. And when
Take the interest rate and multiply it by the tax rate the economy is looking brighter, the debt-free business
which, in this case, is a 10% interest rate multiplied by the often is in the strongest position to take advantage of op-
30% tax rate to equal 7% . In other words, after tax deduc- portunities.
tions, the business is paying the equivalent of a 7% interest Business debt can be paid o when the business is ready
rate. to stop growing. Until then, the bowling center should
While it is true that borrowing enables a business to take leverage all possible funding resources for investment in the
actions or grow at a pace that might otherwise not be sus- operation.
tainable, it also can result in a less- exible business and one If debt is ignored as a business tool, it could hurt the
that takes on greater risk. After all, the more the business operation’s growth.

www.bcmmag.com BCM • APRIL 2024 • 91

3/13/24 7:19 AM
091_Accounting_0424.indd 91 3/13/24 7:19 AM
091_Accounting_0424.indd 91