Debt management ratios are an excellent option which can be used to measure the financial health of a company. Here we have explained its meaning and application.
If you want the details of how a company is doing, you can take a look at the debt management ratios. It’s a measure to indicate how much assets of a company are financed through bank debt. It provides a measure of the amount of money a company raises with the help of creditors, besides giving an idea of how well it is able to manage financial distress. Business debt if used as a financial leverage can provide excellent returns to stockholders, besides allowing an organization to increase profits in the long run. Usually, it represents a cost which is used to finance the assets of a company. It’s only if the firm can earn a profit from these assets that it can remain in business, and that can only be done if there is a proper understanding and monitoring of this ratio.
Also known as debt ratio, they measure how much external credit is used to fund assets. There may be other forms of financing for a company like personal savings and stocks, but these are not included in this ratio. For calculation purposes, you need to divide the total debt by total assets. So the formula is:
Debt Ratio = Total Debt/Total Assets i.e. (Total Assets – Total Owner’s Equity)/Total Assets
Irrespective of whether you are an owner, investor, or just a manager of an organization, the financial health can be analyzed by going through the financial statement and specifically looking at this ratio. If you are an investor, you must know where your money is being used, as it has a great effect on the dividends that you would get. If you as a business owner want to analyze how your enterprise is doing as compared to the competitors in the industry, this statistic can provide you a fair idea for decision-making.
You need to go to the website of the organization in which you have invested, and go through the current financial statement. This will be available on the ‘financial information’ web page. Once you have the financial report, you can easily ascertain the total debt ratio by using the above mentioned formula. Then, you can compare this figure with that of competing businesses. This would provide you an idea of how the company is doing in comparison with its competitors.
You also need to take into consideration the amount a company earns before amortization, depreciation, taxes, and interest, as this measures whether a company would be able to repay debts in the short term. These item totals should be added to the lease payments. The higher the ratio, the better is the company’s financial position.
So, all in all, debt management ratios are a very important component of the financial statement of a company. It provides an indication of how well its business is doing, besides giving an idea of how much is raised from creditors.