Debt Management Ratios

What are 2 interpretations of debt ratio or debt-to-total-assets ratio?

 

1.  indicates the % of assets paid with debt capital

 

2.  (100% - debt ratio)  =  % of assets paid with equity capital

What is another term for times-interest-earned?

Interest coverage

What is an interpretation of times-interest-earned

The number of times that the operating income (EBIT) can cover (pay for) the interest expense

What is leverage?

Using debt or borrowed funds to amplify returns from an investment or project.

What are the risks of leverage?

1. the possibility that the interest expense on the debt could wipe out all of the business’s profits and perhaps cause the business to sustain a loss. 

 

 2. the business may not be able to make the interest payments or pay back the principal, in which case the business could be forced into bankruptcy