Debt to Net Asset Ratio
Financial statement analysis includes calculating a variety of ratios. These ratios fall into three different categories: liquidity, solvency or profitability. Liquidity ratios determine the company's ability to pay its current obligations. Solvency ratios determine the company's ability to continue existing. Profitability ratios determine how much money the company is making. The debt to net asset ratio is a solvency ratio.
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Debt
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Debt refers to the amount of money owed to entities outside of the business. These entities include financial institutions, vendors or bondholders. Debt represents legal obligations of the company to pay each creditor the amount owed by the due date. Debt often incurs interest charges that may be paid throughout the term of the debt or at the end of the term. The company incurs debt in both the short term and the long term. Short-term debt includes accounts payable accounts. Long-term debt includes bonds or long-term loans.
Net Assets
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Net assets refer to the total value of the assets less any adjustments. Adjustments to asset values include accumulated depreciation or allowance for doubtful accounts. Accumulated depreciation reduces the value of the company's fixed assets. Allowance for doubtful accounts reduces the value of the company's accounts receivable. Net assets include both current assets, which are easily turned into cash, and fixed assets, which provide value to the company for many years. Current assets include accounts receivable and inventory. Fixed assets include both plant equipment and buildings.
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Calculating the Ratio
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The company calculates the debt to net asset ratio in three steps. First, the company adds up all of the debt owed by the company, including both short-term and long-term debt. Next, the company adds up all of the assets owned by the company, including both current assets and fixed assets. Finally, the company divides the total debt by the total assets.
Analysis
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Creditors use the debt to net asset ratio when deciding whether they should extend additional credit to the company. The debt to net asset ratio communicates the total assets already financed by creditors. A higher debt to net asset ratio indicates that a greater percentage of the company's assets is financed by debt and represent a greater risk to the company. If a creditor decides to lend additional money to the company, this increases the debt to net asset ratio.
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References
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