Tutorial on Calculating Debt Management Ratios

Calculating debt-management ratios is a useful exercise, especially if you plan to purchase company shares or bonds with a long-term perspective. Also known as economic metrics, these ratios tell you what's going on behind closed doors, with a special focus on how top corporate leadership manages short-term and long-term debts.

Capital Structure

A firm's capital structure is a barometer through which investors tell whether the firm has too much debt. Capital analysis refers to a review of the different avenues that a company explores to fund its activities, including equity and loans.

Quick Ratio

Quick ratio equals cash plus accounts receivable, divided by short-term debts. This metric indicates to lenders and the public whether a firm can repay its current debts with its "quick" assets -- resources that can generate cash within a short period of time, such as a few hours to 10 days.

Current Ratio

Current ratio is less conservative than quick ratio and appraises a company's ability to repay current debts with its current assets. This indicator equals current assets, or quick assets plus inventories, divided by current liabilities.

Debt-to-Equity Ratio

This safety metric evaluates a firm's vulnerability to risk, with an emphasis on how much debt it relies on to finance operating activities. Debt-to-equity ratio equals total liabilities, divided by total equity.

EBIT / Interest

"Earnings before interest and taxes," divided by interest measures whether an organization can meet interest payments. This ratio also evaluates whether the firm can take on more debt without alarming lenders.

Accounts-Payable-Turnover Ratio

A firm's business partners calculate its accounts-payable-turnover metric to determine how quickly the company repays its creditors over a specific accounting period, such as a quarter or fiscal year. A higher number indicates that the business quickly repays vendors. The ratio equals cost of goods sold, divided by accounts payable.

Days-Payable Ratio

Days-payable ratio is an important metric that top leadership relies on to gauge the operating dexterity of purchasing supervisors and vendor-payables managers. This ratio indicates how many days it takes to pay accounts payable -- a cardinal indicator that tells investors whether a company is financially shaky or has sufficient cash in its coffers. Days-payable ratio equals 365 days, divided by the accounts-payable-turnover ratio.

Cash Flow to Current Maturity of Long-Term Debt

This indicator equals net profit plus non-cash expenses, such as depreciation, divided by the short-term portion of long-term debts. It indicates whether a company generates enough cash from operating activities to cover its debts. Depreciation allocates the costs of fixed assets (machinery and equipment, for example) over many years.

References

• Credit Research Foundation: Ratios and Formulas in Customer Financial Analysis
• Missouri Small Business & Technology Development Centers: Financial Ratios
• Joint Base McGuire-Dix-Lakehurst: Experts Say Debt Management Crucial to Financial Success
• U.S. Department of Agriculture: Financial Management and Ratio Analysis for Cooperative Enterprises
• City of San Diego: Debt Management Policy & Plan of Finance