To successfully understand and analyze the debt management ratio of a company, you need to have a copy of the company’s balance sheet as well as income statements.
What is Debt Management Ratio
The Debt Management Ratio of a company, measures the company’s ability to repaying long-term debt by indicating the percentage of a company’s assets that are made possible through debt. In plain terms, it measures much of a company’s operations that comes via debt. The debt ratio is expressed as Total debt / Total assets, which means the higher the ratio, the greater risk that will be linked with the firms operations.
Merits of Debt Management Ratio
Debt management ratio can be very beneficial to an individual, a manager of a business division of a company or an investor. It can be used, to assess financial statements (even your own) to find out the actual strength of your investment as well as your financial strength.
As an investor, you should understand how companies utilize their money to fund their business operations, and how it will directly impact on the amount you as an investor can gain from the investment.
How to Calculate Debt Management Ratio
If you are managing your personal finances and are trying to calculate a debt management ratio.
To pay off debt, you must understand that debt must be proficiently managed. This you can do by reviewing financial statements, which can help corporate managers compare their competence level against that of their competitors.
Working Out a Debt Management Ratio
If you want to help in working out a debt management ratio, you can get counseling from a financial firm that is instituted to help in financial counseling. To do this ;
- Go to the website of the firm to obtain a collection of financial statements. These statements, are available in the company’s information or investor information section of the website. Note, that the annual report is also a valuable resource for these statements. Individuals, can get a detailed explanation about personal balance sheets.
- A good debt management ratio is the Total Debt Ratio which calculates the volume of money the company (or the individual) is utilizing from it’s long-term debt and current liabilities.
How it Works
Total liabilities are to be divided with total assets (both you can get from the balance sheet) to work out a percentage for the total debt ratio. Compare this ratio with the total debt ratio of a competitor company to get to know which firm is more leveraged (i.e.) uses more debt against assets).
An individual, can compare this ratio with last month to keep track of progress.
A bigger ratio or more leverage normally signifies increased probable earnings for the investors. Although, firm managers are exposed to a greater risk because of problems with creditors.
Determine the following, Earnings Before Interest, Taxes, Depreciation and Amortization Coverage Ratio (EBITDA). This, calculates the capacity of a firm to pay off loan obligations for temporary investments (below 5 years). Sum up EBITDA with the lease payments. Then subsequently, divide the figure with the aggregate of principal, interest and lease payments (all listed in the income statement). Thereafter, compare this ratio with that of a competitor company. Note that the higher the ratio, the more capacity the company has to carry out future funding and secure investment.
Individuals can track their debt management ratios with the first one and not bother the last two debt management ratios.