Which Ratios Measure Debt?
1. Debt/Equity Ratio
In corporate finance, it is extremely important to know your debt to equity ratio. This ratio describes the means of financing for any given company, debt referring to a company’s total liabilities, and equity referring to a company’s shareholders equity. The purpose of this formula is to get a number that reflects how much of a company’s equity can cover its debt.
Equation: Debt/Equity Ratio = Total Liabilities / Total shareholders Equities
2. Net Debt
The net debt calculation illustrates a company’s ability to pay off all of its debts if they were to be paid today. This Formula gives us an insight into a company’s liquidity, as it takes into account all debt amounts from the balance sheet, and assets that can be converted into cash quickly (ie. highly liquid assets).
Equation: Net Debt = (Short Term Debt + Long Term Debt) — Cash and Cash Equivalents
Rounding Up
Debt requires two parties, the borrower and the lender. The lender lends the borrower money, and the borrower promises to repay that debt, plus all interest that was specified in their agreement, by some specified date. Debt is a simple concept, but a tricky thing to use if you aren’t wise with your decisions. Finance is full of estimates and risks, but making sure those estimates and risks are calculated will give you the best chance at financial success.
Originally published at https://financialmodelingprep.com.
