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Debt management ratios measure a firm's ability to repay its long-term debt. Two ratios that will be discussed today are:
IN CONTEXT
Let's take a look at the balance sheet for the ABC Company.
The total assets are $27,426. The total liabilities are $12,409 for the current liabilities and $3,450 for the long-term liabilities, for a total of $15,859. If we divide the total liabilities by the total assets, we get 0.58. This means that 58% of ABC's assets are financed by debt rather than by equity. Upon comparison, we may find that this is high and may limit their financial flexibility and borrowing power.
A second debt management ratio is the times interest earned ratio. The times interest earned, or the TIE, measures the company's ability to honor its debt payments. This is also sometimes called interest coverage.
It is calculated by dividing the EBIT, earnings before interest and taxes, by the interest charges.
IN CONTEXT
Let's take a look at another fictitious company.
In this simple example, we are looking for the earnings before interest and taxes. That number here is the operating income of $9,060,000, and the interest expense is $1,610,000. If we divide $9,060,000 by $1,610,000, we get 5.62. So, in this example, this company is in fairly good shape in terms of interest coverage.
Source: THIS CONTENT HAS BEEN ADAPTED FROM LUMEN LEARNING'S “DEBT MANAGEMENT RATIOS” TUTORIAL.
