Working with third-party capital to drive a company’s growth is a common practice, but when poorly controlled, it can cause management problems. To avoid this, it is important to keep constant attention to the debt ratio and make sure that financial commitment is acceptable.
Most entrepreneurs even know the total value of their debts with financing and suppliers, but this number does not have a palpable meaning, since it does not show how much of the capital of the enterprise is compromised. The total amount of debt is only one of the financial indicators that should be evaluated, as well as the index.
We have prepared this indicator to clarify your doubts regarding this important business indicator. Keep reading!
Know the debt ratio
Is it possible to differentiate how much of the company’s activity uses third-party capital and how much is financed by personal capital? That’s where the debt ratio comes in! When explored in a historical series, it reveals the fraction of external resources that the enterprise has used to guide the business and provides essential information for decision making.
The indebtedness index is widely used by companies to discern the extent of assets that the business has, but which are funded by third party resources, that is, by debts that must be settled at a later date.
Find out if the debt ratio is worrisome or not
Essentially, the company’s debt ratio is an indicator of financial performance that aims to show whether the business needs to make debt to continue operating.
The degree of indebtedness of the company considers several successive periods to indicate how the enterprise has done to obtain revenue . For example, he finds out whether the company needs to use a near-capital complement to inject them into its production method or whether it needs to acquire debt as loans to pay other liabilities.
The first case can be pointed out as a good debt level, since the company is borrowing from itself. However, in the second case, there is a great possibility that the business will go bankrupt, so you have to be very cautious.
Learn how to calculate the debt ratio
To do this, you do not have to have specific skills and much less pay to get it. The index is a simple account, whose basic numbers can be easily found on the balance sheet . Check out how to make this account uncomplicated and efficient:
With the balance in hand, find the values of current and non-current liabilities. They demonstrate the amount of third-party capital being used in the company in the short and long term, respectively. Have the total asset value as well.
The debt ratio is the result of the division of the sum of the liabilities by the asset. To obtain the percentage, simply multiply that number by one hundred, as follows:
With this formula, you get the percentage value of your company’s debt. Obviously, the bigger it is, the worse the financial situation you are in. However, there is no default value that indicates a healthy debt ratio. Generally, from 70%, the dependence on third-party capital is excessive.
Interpret the data obtained
One interesting thing about financial ratios is the ability they have to indicate ways and solutions. With the debt ratio is no different.
Even if the amount is high, it is only a worrying number if the company’s commitment is made to cover other debts and obligations, causing the so-called “snowball”. Otherwise, the percentage may indicate that new investments are being made to drive growth.
Even interest on bank financing may be insignificant in the face of increased billing resulting from the expansion of the enterprise. That is, if your company is in this scenario, there is nothing to worry about.
Even when indebtedness is caused by a large number of obligations, it is necessary to review costs and perhaps renegotiate debt to improve working capital and even analyze the balance sheet and the income statement to find exactly what is hindering the performance of your company.
So you have a better chance of reducing the amount of third-party capital in your company, gaining momentum in the asset and manages to improve your power to make financial decisions, depending less on loans to keep the business strong and thriving.
Evaluate the company’s situation
To classify if the debt ratios of a business are at acceptable levels, it is not enough simply to have the present value. It is necessary to follow the historical progress of values and to follow up on monthly, quarterly and annual support. In this way, the longer the time, the greater the assimilation of the manager.
It is also significant that certain comparisons are made. Is a 25% value something good or bad? This will depend on the market in which a certain company is inserted. If all competitors have indices around 12% or 18%, definitely 25% is a high value. In contrast, if they have values greater than 35%, then 25% will be a good value.
These amounts of competitors will rarely be available directly to the companies, since they are strategic and confidential data of the enterprises . However, there are ways to find out the average indebtedness indices of an industry through information from unions, councils or associations representing a particular activity.
The debt ratio is one of the tools for a manager to optimize the financial health of a company, but it is not the only one. A bad index does not mean the end of everything, since it must be ascertained with a set of other variants. Likewise, a good indebtedness ratio alone does not depict reason to celebrate.