Unsecured Debt Ratio
Corporate leadership keeps a close eye on funding initiatives, making sure department heads use borrowed funds efficiently. To reduce a company's unsecured debt ratio levels, senior executives engage in constant discussions with business partners, such as lenders and suppliers. Other notable interlocutors include investors, particularly those who buy corporate bonds with a long-term outlook.
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Definition
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A debt is a liability that a borrower must repay on time. Financial analysts use the term "unsecured debt" to describe a liability for which a borrower has not advanced, or posted, collateral. Posting collateral means providing one or more assets before a lender advances funds. A company's unsecured debt ratio represents the portion of corporate funds coming from unsecured loans. For example, a firm's total assets, liabilities and equity capital equal $1 million, $700,000 and $300,000, respectively. Total liabilities include $400,000 of secured loans and $300,000 of unsecured debt. The company's unsecured debt ratio equals 30 percent, or $300,000 divided by $1 million times 100 percent.
Significance
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Effective debt management and accurate debt-ratio calculation are often the basic facts and focus that guide corporate solvency initiatives. Investors, especially bondholders, make sure corporate borrowers do not use funds inadequately. This is especially true if securities-exchange participants do not see the short-term benefits of top leadership's strategies. The discussion about unsecured debt ratio management may go beyond talking points and tackle tactical issues. These include how corporate leaders intend to repay unsecured loans, the profit potential of a company's products, the firm's market share and ability to raise funds in financial markets and the state of the economy.
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Accounting
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To record unsecured loans, a corporate bookkeeper follows specific rules. These include generally accepted accounting principles and international financial reporting standards. The U.S. Securities and Exchange Commission and the Financial Accounting Standards Board also pitch in accounting standard setting. When a company signs an unsecured loan agreement with a lender, the firm's bookkeeper debits the cash account and credits the unsecured debt account. When the firm repays the loan, the bookkeeper reverses these entries. To record interest payments, the bookkeeper debits the interest-expense account and credits the cash account. The accounting terms of "debit" and "credit" are distinct from the banking terminology. Debiting cash, an asset account, means increasing cash in corporate coffers. This is different from a bank's debit notice, which refers to a reduction in a client's account.
Financial Reporting
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Unsecured debt ratio calculation involves amounts recorded in two financial statements: the balance sheet and the statement of profit and loss, or P&L. Unsecured debt is a liability account that accountants report in the balance sheet, also known as a statement of financial position. Interest expense is a P&L component. Unsecured debt may be a short-term or long-term liability, depending on the loan maturity. If the debt is due within 12 months, accountants report it as a "short-term liability." Otherwise, financial managers report the liability as a "long-term debt."
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