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DEBT RATIOS

Group 1 (Rick, Mai, Xev, Paul) - MBA2


What is Debt Ratio?

The debt ratio is defined as the ratio of


total long-term and short-term debt to
total assets, expressed as a decimal or
percentage. It can be interpreted as the
proportion of a company's assets that are
financed by debt.
Debt Position
This indicates the amount of other
peoples money being used to generate
profits.
The more debt a firm has, the higher risk it
has of being unable to meet its
contractual debt payments and becoming
bankrupt.
Financial Leverage
Financial leverage is the magnification of
risk and return introduced through the use
of fixed cost financing.
Degree of Indebtedness
Measures the amount of debt relative to
other significant balance sheet amounts.
Ability to Service Debt
The ability of the firm to make the
payments required on a scheduled basis
over the life of the debt.
Debt Ratio Formula
DEBT RATIO = Total Liabilities / Total
Assets
The higher the ratio, the greater the firms
degree of indebtedness and the more
financial leverage it has.
Times Interest Earned Ratio
This measures the firms ability to make
contractual interest payments.
Times Interest Earned Ratio = Earnings
Before Interest and Taxes / Interest
The higher its value, the better chance
that the firm will fulfill its interest
obligations.
Fixed Payment Coverage Ratio
This measures the firms ability to meet all
fixed payment obligations.
FPCR = Earnings Before Interest and
Taxes + Lease Payments / Interest +
Lease Payments + {(Principal Payments +
Preferred Stock Dividends) X [1/(1-T)]}
Lower ratio means greater risk to both
lenders and owners.
Profitability Ratio
Profitability ratios are a class of financial
metrics that are used to assess a
business's ability to generate earnings
compared to its expenses and other
relevant costs incurred during a specific
period of time.
Gross Profit Margin
Measures the percentage of each sales
remaining after the firm has paid for its
goods.
Gross Profit Margin = Sales Cost of
Goods Sold / Sales
Gross Profits / Sales
Operating Profit Margin
Measures the percentage of each sales
remaining after all costs and expenses
other than interest, taxes, and preferred
stock dividends are deducted.
Operating Profit Margin = Operating
Profits / Sales
Net Profit Margin
This measures the percentage of each
sales dollar remaining after all costs and
expenses, including interest, taxes, and
preferred stock dividends have been
deducted.
Net Profit Margin = Earnings Available for
Common Stockholders / Sales
Earnings Per Share
This represents the number of earnings
generated during the period on behalf of
each outstanding share of common stock.
EPS = Earnings available for common
stockholders / Number of Shares of
Common Stock Outstanding
This is considered as an important
indicator of corporate success
Return on Total Assets
Also called as return on investments, this
measures the overall effectiveness of
management in generating profits with its
available assets.
ROA = Earnings available for common
stockholders / Total Assets
Return on Common Equity
This measures the return earned on
common stockholders investment of the
firm.
ROE = Earnings Available for Common
Stockholders / Common Stock Equity