The same goes for a manufacturing company, the greater the demand for your product, the greater the equipment needed to meet the demand. What is the demand for your products and services is lower, these are lower labor and material costs. However, fixed cost on the other hand will remain unchanged, even if the activity of your income is reduced to zero, you are still interested in making monthly payments. This, in turn, exacerbates cash-flow problems where your business can face if your business experiences a decline in activity.
Imaging taking a personal mortgage from home and financing a new and a private vehicle, and next month losing a job. No matter whether you have a job or not, you still have to pay monthly mortgages and a vehicle. Depending on your cash reserves, it may take six months before the bank sets up a house and a car, or it may take two months. The same thing happened with any company that can not pay the debt; the company ultimately ends up in the bank’s ownership.
Businesses often seek to purchase equipment that serves a closed-end project that guarantees revenue over a certain period of time. The company can easily carry a debt coverage ratio to determine if it is able to repay the debt. Formula basically runs EBIDA (Profit before interest, depreciation) / Monthly loan disbursement (principal + interest). The one-in-one ratio means that you generate enough cash flow to pay monthly payments; banks usually need a debt coverage ratio of 1.2 to 1.5. The higher the ratio, the lower the risk of debt.
As a company owner you should in future have to anticipate the cash flow for the same amount as the repayment terms for the loan. If the loan has a repayment term of five years, the cash flow forecasts should be for a period of five years. This exercise will help you determine the amount of cash flow you can generate each year, as well as determine the amount of debt your company can handle by simply applying and calculating the debt coverage ratio.