Study Sheet of Debt Management Ratios

Posted by Professor Cram in Ratios of Debt Management

Definitions

  • An Asset is any ‘thing’ a business can own. Buildings, equipment, and vehicles are examples of assets that can be depreciated, while cash, bonds, and inventories are assets that are not depreciated.
  • Amortization is essentially depreciation for intangible assets (like oil wells, goodwill, etc.)
  • Depreciation is the reduction in value of an asset over the course of its useful life. It can be calculated in several ways.
  • EBIT is an abbreviation for “earnings before interest and taxes.” It is found by adding back interest and taxes to net income.
  • EBITDA is an abbreviation for “earnings before interest, taxes, depreciation, and amortization.” It is found by addding back interest, taxes, depreciation, and amortization to net income.
  • Equity is the residual value of ownership shown on the balance sheet. It will always equal “Total Assets” less “Total Liabilities.”
  • Interest is the expense of borrowing money. It can be found on the expense section of the income statement as “Interest.”
  • Liquidity is a company’s ability to meet current obligations using liquid assets.
  • Total Assets is the sum of current assets (like cash), fixed assets (such as buildings), and other assets (i.e., goodwill). It can be found on the balance sheet as “Total Assets.”
  • Total Debt is the combined amount of current liabilities and long-term liabilities. It can be found on the balance sheet as “Total Liabilities.”

Debt Ratio

  • The Debt Ratio indicates how much of the assets are provided through debt.
  • Given the total debt and total assets from a company’s balance sheet:Debt Ratio = (Total Debt) / (Total Assets)
  • Generally, the higher the ratio, the greater the liquidity (ability to meet current obligations using liquid assets).

Debt to Equity Ratio

  • The Debt to Equity Ratio indicates how much financing is provided through debt as compared to equity.
  • Given the total debt and total assets from a company’s balance sheet, use the Debt Ratio:Debt Ratio = (Total Debt) / (Total Assets)

    Debt to Equity Ratio = (Debt Ratio) / (1 – Debt Ratio)

  • Generally, the higher the ratio, the more financial leverage is employed by the firm, and the higher the financial risk.

EBITDA Coverage

  • The EBITDA Coverage Ratio shows if earnings are able to satisfy all financing obligations, including leases and principle payments.
  • Given the EBITDA and lease paid from the Income Statement and the interest and principle paid from the Statement of Cash Flow:EBITDA Coverage = (EBITDA + Lease Paid) / (Interest + Principle Paid + Lease Paid)
  • Generally, the higher the ratio, the more secure the lender’s position. A ratio less than 1.0 indicates an inability to meet financial obligations out of operating cash flow.

Equity Multiplier

  • The Equity Multiplier shows the degree of debt leverage used.
  • Given the Total Assets and Total Equity from the Balance Sheet:The Equity Multiplier = (Total Assets) / Equity
  • Generally, the higher the Multiplier, the more liabilities are used to increase available assets to the company.

TIE Ratio

  • The Times Interest Earned Ratio shows the ability to service interest payments from earnings. This ratio focuses more narrowly than the EBITDA Coverage Ratio which considers other obligations than interest which must also be paid from earnings.
  • Given the Earnings Before Interest and Taxes (EBIT) and Interest from the Income Statement:The Times Interest Earned Ratio = EBIT / Interest
  • Generally, the higher the ratio, the more easily interest obligations can be met out of earnings. A ratio of less than 1.0 means earnings are insufficient to meet the interest payments.

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Comments

One Response to “Study Sheet of Debt Management Ratios”

  1. G. Patterson says:

    Sweet site. Cheers for proviging this. Really found it useful.

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