July 11, 2024

When should I pay down my business debt?

At Brady CFO, we get this question a lot. The answer is that it depends. Some of our clients benefit from paying down their business debt, whereas it doesn’t make sense for others.

It’s super important to know when it’s beneficial and when it’s not because making the wrong decision could put your company at risk of cash flow issues, missed opportunities for growth, or even financial instability. Arriving at the appropriate conclusion requires careful evaluation. There are four key considerations to consider before you decide to pay down your debt.

How to determine whether to pay down your business debt

When deciding whether to pay down business debts, start the conversation by evaluating your current liquidity, upcoming spending, access to outside working capital, and long-term debt amount. Let’s dive into each of these to help you make an informed decision for your company.

1. Evaluate your current liquidity

The best way to do this is to calculate your current ratio. Your current ratio is your current assets (cash, AR, inventory, etc.) divided by current liabilities (accounts payable, current amounts due on long-term debt, etc.). A general rule of thumb is that a current ratio of 1.5 is healthy. If your current ratio is well below this, I suggest building up your liquidity before paying down any debts. Any cash you produce from your business should be kept in your checking or savings accounts to build liquidity.

Building up your liquidity is essential because if you are illiquid and face a serious business challenge in the next few months, it could bankrupt you. You could actually run out of funds to make payroll, pay vendor invoices, etc. You want to maintain healthy liquidity in your business to face short-term obstacles that could arise. So, if you aren't liquid, you aren't in a position to successfully pay down debt.

2. Evaluate your upcoming spending

Consider if you have any big spending that’s outside the norm. For example, you might have plans to upgrade your equipment, invest in new technology, expand your operations, or launch a major marketing campaign. These types of expenses can significantly impact your cash flow. It's best to reserve funds for that potential spend so that you aren't acquiring new debt to make that purchase, especially because new debt in this interest-rate environment is very expensive compared to debt procured in prior years. So, in this case, you wouldn’t spend money to pay down debts.

3. Evaluate your access to outside working capital

Ultimately, this consideration boils down to asking yourself: “If I needed to get a working capital line to cover short-term cash flow deficits in my business right now, do I feel confident I can get it?”

This can be difficult to assess as capital markets can change with changes in economic conditions. A bank’s willingness to lend dries up if their customers default and can't make their payments. Banks aren't always as willing to lend new dollars in complex financial markets. So, if you doubt your ability to get a credit line if you need it quickly, it's best to keep sufficient cash reserves on hand and not focus on paying down business debt.

4. Evaluate your long-term debt amount

Finally, consider if you’re carrying too much long-term debt. A general rule of thumb is that you are too leveraged if your total debt makes up more than 50% of your total assets. However, you are not that leveraged if your total debt is only 10% of total assets.

If you carry too much long-term debt and are liquid, have appropriate cash reserves for upcoming purchases, and have easy access to outside working capital, you should pay down some long-term debt. If you encounter short-term issues in your business that eventually turn out to be long-term issues, having excess long-term debt can be crippling. It could result in you being unable to pay your long-term debt, which is why paying down debt at the right time can be a smart move.

So, should you pay down business debt?

If you …

  • Are liquid
  • Have cash reserves for any large, out-of-the-norm upcoming purchases
  • Have ready access to outside working capital
  • Don’t have any excess long-term debt

… you are in a solid position to pay down additional business debt if you want to. But the question is, should you?

The best choice for your business is whether you can get a better return on the money you have on hand vs. paying down the debt. For example, if you can place your spare cash in a savings account that earns 5% interest while your debt is only at 3.5% interest, it's a better deal to put your cash in a savings account and earn more interest than you’re paying on your debt.

Or, if you can use your spare cash to hire new employees who will generate additional sales and net profits that exceed your debt's interest rate, it makes sense to invest in that growth. This way your investment yields a greater return than simply paying down debt.

When paying down business debt makes sense

As you can see, it's not a simple yes or no answer. Several factors must be considered when deciding whether to pay down business debt.

At Brady CFO, we recently helped a construction client determine it was in their best interest to pay off several high-interest equipment and vehicle loans before placing funds in a high-yield savings account. This was determined after ensuring the business had sufficient liquidity and an available credit line they weren't currently using. This meant this business was well prepared for any short-term concerns. Paying down the equipment debt enabled this construction company to be best prepared for any future negative economic swings that could arise.

Having a financial expert in your corner to help you make these decisions ensures all factors are carefully considered and that your business's unique needs are met. With professional guidance, you can confidently navigate the complexities of cash flow and debt management, making smart choices that benefit your company. This proactive approach not only safeguards your company’s long-term health but also sets the stage for continued growth and success.

Try Ramp for free
Share with
Mason Brady, MBA, CEPAPresident, Brady CFO
Brady CFO is a full-service Fractional CFO firm supporting companies in agriculture, food, manufacturing, logistics, warehousing/distribution, construction & professional services industries. We serve as strategic partners to CEOs and owners to improve profits and cash flow. Our innovative service model provides tools and insights to drive sustainable growth without wasting time and money on inefficient processes or unnecessary expenditures. With Brady CFO, you're investing in a creative and evolving strategy that fits the needs of your growing business.
Ramp is dedicated to helping businesses of all sizes make informed decisions. We adhere to strict editorial guidelines to ensure that our content meets and maintains our high standards.

When our teams need something, they usually need it right away. The more time we can save doing all those tedious tasks, the more time we can dedicate to supporting our student-athletes.

Sarah Harris

Secretary, The University of Tennessee Athletics Foundation, Inc.

How Tennessee built a championship-caliber back office with Ramp

Ramp had everything we were looking for, and even things we weren't looking for. The policy aspects, that's something I never even dreamed of that a purchasing card program could handle.

Doug Volesky

Director of Finance, City of Mount Vernon

City of Mount Vernon addresses budget constraints by blocking non-compliant spend, earning cash back with Ramp

Switching from Brex to Ramp wasn’t just a platform swap—it was a strategic upgrade that aligned with our mission to be agile, efficient, and financially savvy.

Lily Liu

CEO, Piñata

How Piñata halved its finance team’s workload after moving from Brex to Ramp

With Ramp, everything lives in one place. You can click into a vendor and see every transaction, invoice, and contract. That didn’t exist in Zip. It’s made approvals much faster because decision-makers aren’t chasing down information—they have it all at their fingertips.

Ryan Williams

Manager, Contract and Vendor Management, Advisor360°

How Advisor360° cut their intake-to-pay cycle by 50%

The ability to create flexible parameters, such as allowing bookings up to 25% above market rate, has been really good for us. Plus, having all the information within the same platform is really valuable.

Caroline Hill

Assistant Controller, Sana Benefits

How Sana Benefits improved control over T&E spend with Ramp Travel

More vendors are allowing for discounts now, because they’re seeing the quick payment. That started with Ramp—getting everyone paid on time. We’ll get a 1-2% discount for paying early. That doesn’t sound like a lot, but when you’re dealing with hundreds of millions of dollars, it does add up.

James Hardy

CFO, SAM Construction Group

How SAM Construction Group LLC gained visibility and supported scale with Ramp Procurement

We’ve simplified our workflows while improving accuracy, and we are faster in closing with the help of automation. We could not have achieved this without the solutions Ramp brought to the table.

Kaustubh Khandelwal

VP of Finance, Poshmark

How Poshmark exceeded its free cash flow goals with Ramp

I was shocked at how easy it was to set up Ramp and get our end users to adopt it. Our prior procurement platform took six months to implement, and it was a lot of labor. Ramp was so easy it was almost scary.

Michael Natsch

Procurement Manager, AIRCO

“Here to stay:” How AIRCO consolidated procurement, AP, and spend to gain control with Ramp