How Times Interest Earned Affects the Performance of the Company

The total amount of debt of a certain company affects its profitability, its ability to grow and even its business reputation. Debt also creates risk for both stockholders and creditors because of the potential for default. It happens especially during economic crisis, since interest on debt must be paid regardless of financial hardships. Hence, it is important that you are able to compute for the times interest earned of your company. This is important to identify if the company has the capacity to pay its interest expense or if you need to plan for possible countermeasures to solve this problem.

Times interest earned which is also known as interest coverage ratio is another debt to equity ratio that measures the long term solvency of a certain business or firm. It measures how well your company can meet its debt obligations specifically interest expense. This interest coverage ratio is calculated by dividing the EBIT to the total interest expense on long-term debt; where EBIT stands for earnings before interest and taxes. The result or the answer indicates the number of times your company or firm can meet its interest obligations.

The following figures and explanations will help you understand more how to interpret the result of times interest earned ratio and how it affects the performance of your company.

For example: For its fiscal year ending in March 2010, Company KPC has earned £20,000,000 before interest and taxes and had an interest expense of £1,800,000. Therefore: interest coverage ratio = £20,000,000 / £1,800,000 = 11.11

1.    The above figure (11.11) shows that Company KPC has higher times interest earned ratio. This clearly indicates that the company has the capacity to pay off its interest obligations because earnings are significantly greater than annual interest obligations. Even though it owes interest on its long-term loans and mortgages, it can still come up with the money to pay the interest on that particular debt.

2.    However, if Company KPC has arrived at very low times interest earned ratio, say 1.0 or below, it only means that the earnings of the company are insufficient to meet its interest obligations. It may also indicate that the company is running into financial trouble. During this situation, bankruptcy may be one of the recommended solutions to this particular debt problem.

Take note, however, that your company must have high times interest earned ratio to pay off the interest expense. Otherwise, your company will eventually fall. It is ideal and more preferable if the earnings are higher than the interest expense incurred during the previous years. It is because earnings keep on rising and falling depending on the market and economic conditions. Make sure to assess every factor before investing in a company with low interest earned because it imposes risks everytime the economy falters.

Posted by - August 15, 2011 at 9:27 am

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Debt Total Assets – Facts You Ought to Know

Almost every start-up company in any type of industry is always looking for capital to either open or expand their business. This becomes a usual challenge for every entrepreneur or business owner. Many of them have no prior business experience or credit and have been turned down by typical bank programs. However, this scenario can be simply the effect due to their debt total assets ratio – an indicator of one company’s financial leverage.

The debt total assets ratio measures the company’s financial risk by determining how much or what portion of the company’s assets are being financed through debt. Actually, it includes both short-term and long-term debt divided by all assets, both intangible and tangible.

There are a lot of things you should know about debt total assets ratio. This will help you understand the importance of this financial ratio and its significant effect to your company or firm.

How to compute debt to total assets ratio

1.    Initially, you need to look at the liability portion of your company’s balance sheet. You should add together both the current liabilities and the long – term debt. Then, look at the asset portion of the balance sheet. Again, you should add together the current assets and the net fixed assets.

2.     Finally, the debt total assets ratio is computed by dividing the company’s total liabilities by its total assets or debt to total assets ratio = total liabilities / total assets.

Analysis and effects of the ratio to the company or firm

1.    If the debt total assets ratio is less than one, then most of your company’s assets are financed through equity. However, if it is greater than one it only means that your company’s assets are financed through debt.

2.    It is also a common measurement calculated by stockholders both within and outside the company. If your company has a higher degree of debt leverage compared to its assets, then your business is more risky than those companies with lower debt leverage.

To reduce the debt total assets ratio, you will need to find another way to purchase assets. This may include paying for assets with capital earned through its normal business operation, securing private equity investments from private investors or through issuance of stock. The first option is the safest alternative but it is quite difficult to do while the remaining two options are considered better than refinancing through debt.

It is really important to know the debt total assets ratio of your company and learn how to interpret its result. You need to compare this result with other previous years of data, put it in a graph and make some analysis. It is also a good practice if you will compare it with other firms in the same industry. If your debt to total assets ratio is too high, then you need to take a deeper analysis and look for effective countermeasure to solve this problem.

Posted by - August 13, 2011 at 3:48 am

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Significance of Equity Ratio Formula to the Business Sector

One of the most important financial ratios is the equity ratio formula or debt to equity ratio. It indicates the distribution of the company’s debt and tells you if it is under dependent or over dependent on shareholders’ funds. Since most of the finances of a company or firm come in the form of shareholders equity and only a few come from other forms, it is essential to maintain a healthy balance of both amounts in order to function with efficiency and longevity.

Shareholders are those who own shares and stocks of the company. So, they need to be paid of interest on an annual basis including their share amount when the term expires. You must figure out financial planning and financial management solutions to balance the liability and shareholders’ equity. Knowledge on how to compute and interpret for the equity ratio formula is very important. This will point out if your business is doing great or if developments are needed to improve its financial leverage.

There are also other component data you should know in order to interpret the significance of the result of debt to equity ratio to your business or firm. Below are some of those:

Components of equity ratio formula

1.    Shareholders’ funds – This fund is consist of equity share capital, preference share capital, capital reserves, revenue reserves, and reserves representing accumulated profits and surpluses like sinking funds, reserves for contingencies, etc. If there are deferred expenses or accumulated losses, these will be deducted from the total to arrive at the shareholders funds.

2.    Outsider funds – This fund includes all debts and liabilities to outsiders, whether short term or long term in the form of bonds, debentures, mortgages or bills.

How to compute equity ratio formula and interpret its result

1.    To compute for the debt to equity ratio, simply divide the total liabilities to shareholders equity; where total liabilities is equals to long term debt plus short term debt. Once you have learned how to compute debt to equity ratio, it is equally important to understand its significance as well.

2.    Through equity ratio formula, you are able to determine the nature of the money that is used for financing the assets of the business organization. Hence, when your company depends heavily on shareholders equity, then this could be a disadvantage. Investing in companies or firms with higher result of debt to equity ratio is more risky compare to those who have lower equity ratio.

Again, to further understand the significance of the result of equity ratio formula as well as its effect to the business, you should compare it with the previous year data; say three to five consecutive years. You should also compare your data with other companies in the same industry to assess your performance over them. This will give you an idea about the capital structure of the company, its liability and asset management. Maintaining a good ratio is crucial for the success and functionality of any business organization.

Posted by -  at 2:43 am

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Debt to Equity Ratio

Despite how intimidating the term sounds, debt to equity ratio is a lot easier to understand than you might imagine. Sure, banks and investors toss the term around in a way that may have you sinking in your seat but it’s really not that complex, they just want you to think that it is!

There are quite a few elements that are used by investors who are trying to determine which stocks will offer them the greatest return on their investment. These are the stocks that they want to add to their personal portfolio. A company’s debt to equity ratio just happens to be one of these elements.

Understanding the Term

Debt to equity ratio basically measures the leverage that a company has. This is a good indication of their solvency, which is how much total liabilities are exceeded by total assets. If the number is negative, the company isn’t a good risk, if it’s positive, the company is very attractive (from the investment standpoint).

Financial institutions generally use the debt to equity ratio not only to determine if the company is a sound investment but also to decide an interest rate that should be offered. A company with a high ratio will traditionally be required significant repayment against the debt because of the risk the lender is taking.

On the other hand, companies who offer an attractive debt to equity ratio are eligible for foreign investment, lower rates and more opportunities that would otherwise not be available.

Calculations

Determining debt to equity ratio is relatively simply. You are trying to determine the ratio that remains after liability is divided by equity from all the shareholders. Simply put, this is the figure you get when you subtract liabilities from assets.

Mortgages, loans and accounts payable are all considered liabilities. An even easier way to understand debt to equity ratio is it’s the amount that is owed divided by what is owned. The lower the number, the more attractive the investment.

Using These Figures

If you are looking to invest in a company, debt to equity ratio must play a key role. A high ratio should raise a red flag that a company either needs to deal back is spending or it’s simply not profitable. On the other hand, a low ratio doesn’t always prove success, it could also be an indication of a stagnant company.

When using debt to equity ratio, you always want to compare these figures with the market and competition. A number that doesn’t seem attractive to you may fall right in line with the current market.

Posted by - July 29, 2011 at 5:02 am

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