What is Debt Service?
The Short Answer
Debt Service explained simply
Debt service refers to the money a business needs to pay back its loans. This includes two parts: the interest, which is the cost of borrowing money, and the principal, which is the original amount borrowed. Businesses need to make sure they have enough cash flow to cover these payments to avoid defaulting on their loans.
Real-World Example
The Coffee Shop Loan
Imagine a coffee shop owner takes out a $100,000 loan to buy new equipment. The loan has a 5% interest rate and requires monthly payments of $1,000. Each $1,000 payment covers both the interest for that month and a portion of the original $100,000 principal. The total of these monthly payments is the coffee shop's debt service.
Why this matters
Understanding debt service is crucial for any business owner. It directly impacts your cash flow and profitability. If your debt service payments are too high compared to your income, your business could struggle to stay afloat. It also affects your ability to get future loans, as lenders look at your debt service coverage.
Always know your debt service obligations. It’s a key number that tells you if your business can handle its loans. Don’t overextend yourself.
Always know your debt service obligations. It’s a key number that tells you if your business can handle its loans. Don’t overextend yourself.
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