What Is a Debt-to-Sales Ratio?

Edited by Hannah Locklear

Summary: Debt-to-sales ratio is a percentage that represents your company’s ability to make revenue in order to cover its debts. To calculate your debt-to-sales ratio, divide your business’s total annual amount of debt by its total annual sales. You can reduce a high debt-to-sales ratio by making more sales and reducing debt. If you are struggling with debt, SoloSuit can help you respond to debt collectors in and out of court and settle your debts for good.

If you’re a business owner, you might have borrowed a business loan from a bank or other lender to get your business off the ground or fund expensive operations. If so, your business’s debt to sales ratio becomes a key metric of your company’s financial health and an indicator of potential actions you may have to undertake.

If you’re considering taking out a business loan or have already taken one out, understanding your debt-to-sales ratio is paramount to guiding your business’s long-term financial plan. To help you out, this guide will explain what a debt-to-sales ratio is and give advice on how to manage it.

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Defining Debt-to-Sales Ratio

To start off, a debt-to-sales ratio is a percentage that compares your company’s total annual debts owed to its total annual sales made. It’s used as a financial health metric to determine how reliant your company is on debt to finance its operations and tells investors and analysts how well your company can service its debts and pay back creditors.

A business might choose to take on debt to help cover startup costs, hire more employees, expand operations, or otherwise purchase capital expenditures. Companies take on business loans with the hopes that the money invested can generate enough profit to pay off the loan in the long term.

To be clear, a debt-to-sales ratio is not the same thing as a “bad debt to sales ratio,” which is an internal accounting measure of how many uncollectable customer accounts received (bad debt) a company has to write off as expenses.

Calculate a debt-to-sales ratio

To calculate your debt-to-sales ratio, divide your business’s total annual amount of debt by its total annual sales. For example, if your debt for this year was $75,000 and you made $150,000 in sales, your debt-to-sales ratio would be 50%.

With a debt-to-sales ratio, a company can track its own financial health over time, compare its debt management to the industry average, identify potential opportunities to take on more debt, and evaluate its risk profile.

What is a healthy debt-to-sales ratio?

What’s considered a healthy debt-to-sales ratio will depend on your business and larger industry and economic trends. For example, your company size, business model, and profit margins will affect your debt-to-sales ratio. Macroeconomic factors such as a recession would also affect your debt-to-sales ratio as consumers spend less and you make fewer sales. A company’s debt-to-sales ratio may also be skewed higher if the company takes on a debt with a longer maturity period.

Because of these different factors, it’s recommended to use a company’s debt-to-sales ratio as only one metric by which to measure its financial health; other metrics should be used in conjunction. With all of the individualistic factors contributing to a company’s debt-to-sales ratio, a company would be wise to track its debt-to-sales ratio over time to create a baseline for what’s considered healthy for its specific operations and situation.

As compared to the business’s own performance and industry standards, a high debt-to-sales ratio is seen as risky to creditors and investors, as it means the company is potentially overleveraged and in a tenuous financial position. If economic conditions change or sales begin to flag, the company could be at risk of defaulting on its loans.

Meanwhile, a low debt-to-sales ratio is seen as favorable, as it means the company is more self-sufficient. Creditors would be more willing to lend to businesses with a low debt-to-sales ratio, as it means the business can generate sufficient cash to cover its debts over time.

Manage your debt–to-sales ratio

If you have a high debt-to-sales ratio and are looking to reduce it, there are two ways to do so: making more sales and reducing your debt.

Make More Sales

The first way you can improve your debt-to-sales ratio is by making more sales and increasing revenue, which will improve your ability to pay off debts. Unfortunately, specific advice for how to increase your sales figures depends on whether you’re a B2B or B2C company, your industry, your customer base, and other factors – each business is different, so what improves sales for one company might harm sales for another.

But if you’ve just started your business and don’t know where to begin scaling up your operations, the very first thing you should do is set up your sales pipeline, a repeatable set of sales procedures that will act as a framework for all the sales you make.

With an established sales pipeline, you can ensure that each sale is the same as the last, smoothing out management and building a consistent customer experience. With a repeatable sales process, making more sales will be much easier.

Reduce Your Debt

On the other side of the ratio, the other way to lower your debt-to-sales ratio is to decrease the amount of debt you’re in. You can do this by paying off your debts early and refinancing your debt at a lower rate.

If your situation changes abruptly and you find yourself unable to pay off your minimum, you could also try to talk with your lender to renegotiate the terms of your loan. This may not decrease your overall amount of debt, but it could give you some more time to pay off other loans first.

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Conclusion

The debt-to-sales ratio is an important metric for measuring a company’s financial health and is calculated as the percentage of a company’s annual debts owed to its annual sales made. If a company has a high debt-to-sales ratio, it may be vulnerable to defaulting on a loan and could be denied if it attempts to apply for further loans. That’s why a company would be wise to monitor this metric, and take steps to make more sales or decrease its debt should its debt-to-sales ratio get too high.

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