One of the most important steps in the evaluation any time a firm like investors and creditors, is the analysis of debt. Debt is not fundamentally harmful, nor helpful, and many businesses borrow through standard loans or by issuing bonds. In fact, since interest payments on debt can be tax deductions, they often represent a more cost-effective way to expand debt at the expense of equity. Getting into debt, becoming more and more borrowed funds becomes problematic when it is done too often or in too large scale.
Fortunately, you can use the information provided through financial statements of the company, to help to understand enterprises that are responsible to take from those that do not. Debt is an obligation, so debt will be reported on the balance sheet. However, just looking at the total amount of debt is not to tell you thank you about the financial health of the company. Instead, the dealers and lenders use ratios to use for comparison of different levels of debt.
The ratio of debt to equity
The best known and most widely used leverage is the ratio of debt to equity. There are different versions of own and borrowed funds, so you must understand that you are looking for and why. The debt ratio, which divides total liabilities by Charter capital, it is very useful for bondholders, as it provides a rough estimate of how much is left if the company is liquidated.
Instead, you could see the ratio of own and borrowed funds, which divides long-term debt to Charter capital. Ignoring short-term liabilities, this version is more focused on borrowing that was done for profit in the future. The third debt to equity formula divides the sum of long-term debt plus preferred stock to common stock. You use this if you are concerned about the amount of interest or dividend obligations with respect to the company.
The Interest Coverage Ratio
A different ratio of the levers are connected with the interest coverage ratio interest payments. Only one problem with the review is the amount of debt obligations of the company, they will not tell you anything about the company’s ability to service debt. This is exactly what the interest coverage ratio aims to correct. This ratio, which is equal to operating income divided by the interest expense, and demonstrates the company’s ability to pay interest. Do you want to see a ratio of 3.0 or higher, although this depends on industry. (For associated reading, see: what is a good interest coverage ratio?)
Times interest (tie), also known as the coverage ratio of fixed charges, the change in the interest coverage ratio. This ratio attempts to allocate cash flow in relation to interest payable on long-term obligations. To calculate, find the company’s profit before interest and tax (ebit) and then divide by interest expense long-term debt. The use of pre-tax earnings, because the interest rate tax; the amount of revenue can be used to pay interest. Again, higher numbers are more favorable.
In some industries, of course, more debt-intensive than others, so compare the ratio of own and borrowed funds between like competitors in the same sector. Also look at ratios within a certain period of time, and not just for one particular period and look for trends. For example, the operating profit, which is growing at a slower pace than interest expenses-is not a good sign. (For associated reading, see: understanding the ratio of own and borrowed funds.)