TLDR
Debt isn’t inherently good or bad. It depends on how and why it’s used.
Financial challenges often build over time – debt management plays a key role in maintaining long-term stability.
Understanding what liquidity, solvency and leverage really mean can help you make better borrowing decisions.
Healthy debt can support growth and flexibility, while unhealthy debt creates pressure and limits your options.
Whatever the economic environment, Canadian businesses face both financial pressure and opportunity in any given year. Today, those forces are more pronounced. Costs are rising, access to capital is shifting, and many businesses are relying on credit to manage day-to-day operations or fund growth.
There’s nothing inherently wrong with that. Debt can smooth out bumps in cash flow, fund expansion and help businesses operate more efficiently. But it can also introduce risk – especially when it’s taken on without a clear plan. This is because small decisions can quickly compound. In the end, the difference between debt that supports your business and debt that creates pressure often comes down to how well it’s planned from the start.
According to Equifax Canada’s Q4 2025 Market Pulse, financial trade delinquencies rose over 9 per cent year-over-year. At the same time, the Canadian Small Business Health Index declined 2.4 per cent over the same period, pointing to weakening business resilience as debt loads and credit stress rises.
While these trends indicate that a growing number of businesses are struggling to meet their obligations, it doesn’t mean that debt itself is the problem. The issue is in how it’s being used.
The takeaway? Debt isn’t something to avoid altogether – it’s something to use strategically. Understanding how borrowing can support your business’s resilience can help position it for long-term success.
| Concept | Definition | Time Frame | Why it Matters | Example |
|---|---|---|---|---|
| What is Liquidity? | Your ability to cover short-term obligations like payroll, inventory or loan payments | Next 12 months | Even profitable businesses can run into trouble without cash at the right time | Having enough cash on hand to make payroll during a slow month |
| What is Solvency? | Your long-term financial health – what you own versus what you owe | Long-term | Determines whether your business can sustain itself over time | Assets exceeding liabilities on your balance sheet |
| What is Leverage? | How much of your business is funded by debt versus equity | Ongoing | A strategic tool that can support growth – or create risk if misused | Taking on a loan to invest in equipment that increases output |
How these concepts work together
Understanding each of these concepts on its own is useful, but the real insight comes down to how they interact. Liquidity, solvency and leverage are closely connected and focusing too heavily on one while overlooking the others can create blind spots in your financial strategy.
For instance, a business can be:
- Liquid but not solvent, meaning it can pay the bills today, but is carrying too much long-term debt to stay financially healthy over time
- Solvent but not liquid, where it is financially sound overall, but short on cash flow right now
Strong businesses manage both and use leverage in a way that supports each measure of financial health.
This is where planning becomes critical, as decisions around borrowing, repayment and investment all contribute to how these three measures evolve over time.
Need support tracking cash flow? Accounting platforms like Xero can make it easier to monitor liabilities and stay on top of repayment timelines.
When debt can become a problem
Debt-related challenges rarely happen all at once. More often, they build gradually, as small decisions that add up over time.
Understanding your debt position can help you stay in control and make more informed decisions. And when used thoughtfully, debt can support your business. Without a clear strategy, on the other hand, it can put pressure on your bottom line.
Warning signs of unhealthy debt
If any of the following sound familiar, it may be time to take a closer look at your approach to debt. The sections that follow outline several ways to address these challenges and regain control:
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Borrowing to cover routine expenses: Using credit for payroll, rent or inventory can indicate a cash flow issue.
If payroll is becoming difficult to manage, solutions such as ADP payroll services can help streamline processes and improve visibility into your ongoing obligations.
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Taking on new debt to pay for existing loans: Refinancing or stacking loans to stay afloat can quickly become a cycle that’s difficult to exit.
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Blurring personal and business finances: Using business debt to fund personal expenses makes it harder to track performance and manage obligations.
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No clear repayment plan: Debt taken on without a defined path to repayment tends to linger – and ultimately grow.
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Rising debt with flat or declining value: If your liabilities are increasing but your income isn’t, your risk is compounding.
A quick self-check: Are you over-leveraged?
Before taking on more debt – or if existing obligations are starting to feel tight – it’s worth stepping back to assess your position. A simple self-check can help you determine whether your current level of debt is still supporting your business or beginning to cause strain.
- If revenue dropped by 20%, could I still meet my obligations?
- Do I know exactly how and when each debt will be repaid?
- Is my debt helping generate revenue, or just covering gaps?
If the answers are unclear, it may be time to reassess your approach. That could mean reviewing your cash flow more closely, prioritizing repayments or speaking with a financial advisor or lender about restructuring options before small issues become bigger.
Tools like the RBC Business Cash Flow Calculator can provide an analysis of your current cash flow position and offer advice and resources to help you manage it better.
The opportunity: When leverage builds resilience
When used strategically, debt can be a lever to effectively build your business – and your ability to weather fluctuations in revenue, demand and cash flow.
Used well, leverage can:
- Fund expansion into new markets
- Support hiring or capacity growth
- Smooth seasonal cash flow fluctuations
- Allow you to invest ahead of revenue
What differentiates healthy debt from harmful debt is that it is tied to a clear outcome – and comes with a realistic path to repayment.
Keep in mind, funding doesn’t need to come from debt alone. Government grants and funding programs identified through partners like GrantMatch can help offset costs and boost your financial position without adding to your liabilities.
The story of two businesses
To see how the use of leverage can play out in business, consider these two examples:
Business A: Debt-free, but exposed
Business A has taken a conservative approach to its business growth. They avoid borrowing wherever possible and operate with minimal debt.
On the surface, this looks strong, but the business also:
- Holds limited cash reserves
- Has not invested in operational efficiencies
- Relies heavily on steady revenue to cover costs
When demand slows unexpectedly, the business has limited options. Without access to capital or cash buffers, it’s forced to cut costs quickly, negatively impacting its long-term performance.
Result: Despite having little debt, the business is vulnerable due to low liquidity and limited flexibility.
Business B: Strategically leveraged
Business B uses debt more actively, but also with discipline to keep it manageable.
It has:
- Secured financing to invest in equipment and systems that improve efficiency
- Maintained a cash buffer for short-term needs
- Structured its debt with manageable repayment terms
When the same slowdown hits, Business B can draw on its reserves and make measured adjustments, such as slowing hiring, delaying non-essential spending, renegotiating supplier terms or pacing new investments. Because it isn’t under immediate pressure, these decisions can be made thoughtfully rather than reactively.
Result: The business remains stable, having used debt strategically to boost its resilience and reserves.
Questions to ask yourself before borrowing
Debt isn’t something that needs to be avoided. The goal, rather, is to ensure it’s working for you. Before taking on new financing, consider the following:
- What specific outcome will this debt support?
- How will it generate revenue or improve efficiency?
- What does the repayment timeline look like? And can you keep it up under different scenarios, such as a drop in revenue or surprise expenses?
- How will this affect my liquidity and solvency?
These questions shift the approach to borrowing from a reactive decision to a strategic one.
Strong borrowing decisions often begin well before financing is in place. In fact, they begin with a clear plan for how debt will support your business and how it will be repaid from the outset.
If you’re planning to take on financing, tools like the RBC Business Plan Builder can help you map out how the investment supports your goals – and how you’ll manage repayment over time.
Debt doesn’t need to be avoided, but it does need to be understood. Businesses that manage leverage well aren’t necessarily the ones with the least debt, but the ones that use it strategically. By keeping a close eye on liquidity, solvency and how your debt supports your overall goals, you can make decisions that strengthen your business today – and over time.
FAQ
No. Debt becomes problematic when it’s used to cover ongoing gaps rather than support growth or efficiency. Strategic borrowing can strengthen a business.
If your debt is tied to a clear return – i.e., increased revenue, improved margins or efficiency gains – and you have a plan to repay it, it’s more likely to be healthy.
There’s no universal number. It depends on your industry, cash flow stability and margins. A practical test is to forecast whether you could still manage your obligations if revenue dropped meaningfully.
Both liquidity and solvency are important factors of a healthy business. Liquidity keeps you operating day-to-day, while solvency contributes to your long-term survival. Strong businesses balance the two.
Build a more resilient business
Explore more ways to strengthen your financial foundation:
How to Build Financial Resilience With Smart Cash Flow Management
This article is intended as general information only and is not to be relied upon as constituting legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. Information presented is believed to be factual and up-to-date but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or any of its affiliates.
