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Debt Management Ratio:
Useful Tool To Assess Use of Debt
A debt management ratio can help you whether you’re an individual, a manager of the business division of a company or an investor. You can use it to assess financial statements (even your own) to find out the actual strength of your investment and/or your financial health.
Investors should understand how companies utilize their money to fund their business operations, which has a direct affect on the amount the investor can gain from the investment.
This doesn't change (in essence) if you're managing your personal finances and trying to calculate a debt management ratio.
To pay off debt, debt has to be managed proficiently. Reviewing financial statements can also assist corporate managers to compare their competence level with that of their competitors.
Is the firm or you as individual doing the most appropriate usage of debt? Working out a debt management ratio is a useful technique to discover this for yourself.
If you want help you can get counseling from debtconsolidationcare.com for instance.
- Visit the website of the firm to get a collection of financial statements. These are normally available in the company information or investor information section of the website. The annual report is also a valuable resource for these statements. If you're an individual you can find an explanation about personal balance sheets by clicking here.
- A good debt management ratio is the Total Debt Ratio that calculates the volume of money the company (or you) is utilizing from its long-term debt and current liabilities. Total liabilities are to be divided with total assets (you can get both 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 find out which firm is more leveraged (utilizes more debt against assets).
If you're an individual, compare this ratio with the last month to track progress.
More leverage or a bigger ratio normally implies increased probable earnings for the investors, nevertheless, firm managers are exposed to risk due to problems with creditors.
- Determine the Earnings Before Interest, Taxes, Depreciation and Amortization Coverage Ratio (EBITDA) that calculates the capacity of a firm to pay off loan obligations for temporary investments (below 5 years). Sum up EBITDA with the lease payments and subsequently, divide this figure with the aggregate of principal, interest and lease payments (all mentioned in the income statement). Compare this ratio with that of a competitor company. The higher the ratio, the more is the capacity of the firm to pay off its loan obligations if necessary.
- Calculate the Times-Interest-Earned Ratio, which works out how capably the company can fulfill yearly interest costs in the end. You just divide EBIT (Earnings Before Interest and Taxes) with the interest (available in the income statement). Compare the Times-Interest-Earned Ratio with that of a competitor company. The higher the ratio, the more is the capacity of the company to carry out future funding and secure your investment.
If you're an individual don't worry about the last two debt management ratios you can well track your progress with the first one.
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