For Subscribers

Debtor, Beware Make sure you're spending wisely at startup.

By Rosalind Resnick

Opinions expressed by Entrepreneur contributors are their own.

Question: How much debt is safe to get into when starting a business?

Answer: No more than you can handle without going broke. While many entrepreneurs launch businesses on their credit cards or by taking out home equity loans, it's risky to pile on too much debt before your company starts making a profit. If your business can't kick off enough cash to cover your monthly interest expenses, you risk defaulting on the loan and putting your home and business in jeopardy.

Once your company starts making a profit, you'll have many more options. One popular form of debt financing is a credit line secured by your company's accounts receivable. Unlike a loan that requires you to make fixed monthly payments of principal and interest, a credit line allows you to draw down only the money you need and to pay interest only on the amount you borrow.

No matter what kind of debt financing you use, the key is to keep your debt service at a manageable level. Justine DeVito Tenney, partner in the Private Business Group at accounting firm Weiser LLP in Lake Success, New York, advises as a rule of thumb that businesses maintain a debt service coverage ratio of at least 1.2 to 1--that means $1.20 of cash flow for every $1 of interest and debt payments.

DeVito Tenney also recommends that new businesses prepare detailed estimates of their monthly and annual cash flows to make sure they don't get caught short. "Even if total cash flows are sufficient to meet obligations as they come due, the timing of cash inflows may not match scheduled payment dates of liabilities," she says. In other words, when it comes to debt financing, it's better to go slow than to go for broke.

Rosalind Resnick is the founder and CEO of Axxess Business Consulting, a New York City consulting firm that advises startups and small businesses.

Rosalind Resnick is a New York-based freelance writer, entrepreneur, investor and author of The Vest Pocket Consultant's Secrets of Small Business Success.

Want to be an Entrepreneur Leadership Network contributor? Apply now to join.

Leadership

Lead From the Top: 5 Core Responsibilities of a CEO

Knowing exactly what the chief executive's role entails is critical for steering a company to success.

Business Solutions

Own Office 2021 and Windows 11 Pro for Only $44.97

Get 89% off MSRP on this Microsoft Office and Windows 11 Pro bundle.

Business News

Meta Is Reportedly Paying an Apple Engineer Over $200 Million to Join Its Superintelligence Effort

The former Apple distinguished engineer will receive most of the compensation in stock awards.

Growing a Business

The Future of Work Is Flexible and Fractional — But It's Still Failing. Here's How to Fix It.

Technology has already dissolved geographic borders, while a new generation of workers has fundamentally redrawn the line between career and life. In this modern landscape, entrepreneurs can either cling to the "best practices" of the past or embrace a future built on flexibility and trust.

Side Hustle

They Started a Side Hustle Producing an 'Obvious' Food Item. It Hit $300,000 Monthly Revenue Fast — On Track for Over $20 Million in 2025.

When Jason Rosenbaum and Hailey Swartz couldn't find the product they wanted to see on grocery store shelves, they took matters into their own hands.

Business News

Hackers Access Personal Data of Millions of McDonald's Job Applicants Thanks to Absurdly Easy-to-Guess Password

Lax secuity measures on McDonald's AI-powered "McHire" site made the personal info of tens of millions of job-seekers vulnerable.