Investing Guide · Chapter 6
Deciphering Debt: A Crucial Aspect of Business Health
Evaluate debt levels and their impact on investment risk.
Borrowing itself is not an issue—it's the extent of borrowing that matters. Excessive debt relative to income creates financial instability.
The Three-Year Rule
A core principle for evaluating debt health: businesses should be able to pay off long-term debt within three years using operating cash flow. Calculate by dividing Total Long Term Debt by current Operating Cash Flow.
Evaluating Debt
Analyze actual dollar values rather than percentages alone. Consult the Balance Sheet's Long Term Debt section for accurate assessment.
The Rule #1 Philosophy on Debt
While zero debt is ideal, strategic borrowing for valid business purposes is acceptable provided repayment is feasible and timely. Rule #1 investors prioritize certainty and predictable earnings, making high-debt businesses risky investments.
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