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finance??????????
finance??????????
In trying to judge whether a company has too much debt, what financial ratios would you use and for what purpose?
Answers:
Simon O: Ok. Ill make the assumption you're 18ish or below? Is that right?
If so then the main curriculum style ratio you'll want is GEARING. Which measures debt to equity.
This is the companys long term debt/ shareholders equity + long term debt.
So for instance if a companies long term debt/debentures are $50,000, and its shareholder equity/total book value of its shares is $60,000. Its gearing is $50,000/$110,000.
That bottom line of the formula is the same as the 'net book assets' figure and 'total shareholder funds' figure.
For this ratio. Over 50% is considered quite highly geared. The higher geared you are, the more risky a company you become, because of those huge interest payments you have to make on that debt, even in bad times. If your company is 100% geared, I.E Funded entirely by loans. Then you MUST generate a return on that money of more than the interest rate otherwise you could be instantly declared bankrupt. Its because of this risk, that lenders will look at a companies gearing before it decides to lend. If gearing is higher than 50-60% then banks will start becoming wary, regardless of the financial performance.
So to word my answer like your question, the purpose of using gearing is to assess the risk of the firm due to its 'capital structure', that is, the way the firm is funded. This risk affects how much it will cost to lend from banks and other people. The higher the risk, the higher the interest rates the new lenders would charge it.
I hope thats enough infomation.
Si
Thats a brief intro to gearing and its impact on a firm. I doubt you'd use any other ratios.
2008-04-07 07:47:48
If so then the main curriculum style ratio you'll want is GEARING. Which measures debt to equity.
This is the companys long term debt/ shareholders equity + long term debt.
So for instance if a companies long term debt/debentures are $50,000, and its shareholder equity/total book value of its shares is $60,000. Its gearing is $50,000/$110,000.
That bottom line of the formula is the same as the 'net book assets' figure and 'total shareholder funds' figure.
For this ratio. Over 50% is considered quite highly geared. The higher geared you are, the more risky a company you become, because of those huge interest payments you have to make on that debt, even in bad times. If your company is 100% geared, I.E Funded entirely by loans. Then you MUST generate a return on that money of more than the interest rate otherwise you could be instantly declared bankrupt. Its because of this risk, that lenders will look at a companies gearing before it decides to lend. If gearing is higher than 50-60% then banks will start becoming wary, regardless of the financial performance.
So to word my answer like your question, the purpose of using gearing is to assess the risk of the firm due to its 'capital structure', that is, the way the firm is funded. This risk affects how much it will cost to lend from banks and other people. The higher the risk, the higher the interest rates the new lenders would charge it.
I hope thats enough infomation.
Si
Thats a brief intro to gearing and its impact on a firm. I doubt you'd use any other ratios.
2008-04-07 07:47:48