In the economic system that prevails today, there are a large number of instruments and tools to undertake all kinds of businesses and investments worldwide. Nevertheless, raise a small company, ensure the preservation of an already consolidated company, It is extremely important that we learn to perfectly handle some of these instruments, so that they allow us to guarantee the optimal functioning of our company and business.
For people who know the subject, no one will fail to recommend that we pay special attention to managing the debt ratio, an essential knowledge to carry out any business proposal.
What is the debt ratio?
The debt ratio is one of the most widely used financing ratios today. The reason is that it is one of the instruments that make it possible to obtain very important information to measure and calibrate the financial health of a company. Simply him debt ratio It enables us to measure financial leverage, in other words, the maximum amount of debt that a given company can handle. In a way, the financial ratio indicates the external financing that the company has.
Have a better idea of what the debt ratio entailsIt should be noted that although debt is measured, to put it in a certain way, based on the company's dependence on third parties, the debt ratio is used to specify to what extent or extent the company depends on the different financing. entities, such as banking organizations, shareholder groups or even other companies.
Another way to understand this financial concept is from the next explanation.
First you have to pay attention to what some essential concepts mean, as an example: assets, liabilities or equity.
Assets are the total value of everything owned by a company or trade association.; In other words, it is the maximum value that the company can have through the various assets and rights it owns, which can definitely be converted into money or another similar means that provides liquidity to the company. Liabilities, on the other hand, represent all the external resources that can be obtained through various instances, in other words, their financing.
From this dynamic, it can be said that although liabilities comprise financial assets and rights, liabilities are made up of credit obligations, in other words, debts and payments to be made, either for loans acquired with banking organizations or purchases made. . on credit with the different suppliers.
In short, the liability represents everything that the company owes to third parties, such as banks, taxes, salaries, suppliers, etc. Last we have the company's net worth, which, as its name might suggest, are all the net resources that the company has, leaving aside the cost of liabilities, in other words, They are the assets that take away the value of all the debts that must be paid, so the net worth of a company is obtained by subtracting the liabilities from the assets. As an example, if a company has an asset worth 10 million euros, but its liabilities accumulate around two million euros, then it can be inferred that its net worth is 8 million euros.
Once we know some essential definitions around the debt ratio, Afterwards, we can already pay attention that in most cases, many companies handle external sources of financing, in other words, they use loans and credits when they are in periods of exponential growth or when they handle a great diversification of businesses, as a way of Example: to finance investments or cover payments for certain current expenses; reason for which they have to depend on debts with various financial organizations, suppliers and other companies.
In this way, the debt ratio can be understood as the difference between external financing and the company's own resources, so that it is known if the debt contracted with the company can be sustained with the resources available. When it is detected that the company no longer has the means to pay a certain debt, then it chooses to leave this method of financing behind, so as not to have problems with future payments that must be made. This is how the debt ratio can be a very useful instrument, which if used in a responsible and disciplined way, serves to avoid economic setbacks that can cause the total disappearance of a company or business.
How is the debt ratio interpreted?
By making use of this financial product, we must remember that this tells us how many euros of external financing the company has for each euro of equity you must meet your various financial obligations. In other words, it indicates the percentage of the total amount of the company's debts, linked to the resources it has to settle its respective payments.
Thus, if we have a debt ratio of 0.50, this indicates that external resources, in other words, financing through loans and credits constitutes 50% of the company's own resources. In other words, if the debt ratio is 0.50, that means that for every 50 euros of external financing, the company has about 100 euros of equity.
In practice, the optimal values of the debt ratio They depend a lot on the type of company, the financial ideology it manages, its size and the total resources it has to face any type of eventuality. However, in general, the generally accepted criterion for an optimal debt ratio is between 0.40 and 0.60. From this dynamic, the most recommended by financial specialists is that the debts of the companies represent between 40% and 60% of what total equity represents. In this regard, it is contemplated that a debt ratio greater than 0.60 implies that the company is excessively indebted, while one less than 0.40 implies that the company has too many resources that are not being used properly for a feasible expansion.
How is the debt ratio obtained?
The debt ratio can be calculated from the sum of all the debts that have been incurred, both short and long term. Once you have this information, it is divided by the total liability, which is obtained by adding the net worth plus current and non-current liabilities (also known as equity). Afterwards, the result must be multiplied by one hundred, to obtain from this dynamic the percentage of the debt ratio with which the company has. The formula to perform this calculation is as follows:
Short and long term debt ratio
Especially, there are two main debt ratio formulas, that are used depending on the moment of the debt that the company has. The first is that of external funds or short-term debt (RECP). The other is that of external funds or long-term debt (RELP).
The RECP is a method that deals with measuring short-term debts or current liabilities, which are divided by net worth. On the other hand, the long-term debt ratio is obtained by dividing the debts or current liabilities acquired in the long term, by the net worth.
Often times, the strategy used by many companies is that of long-term external financing, since this modality allows them to face the debt in a longer period of time, and in this way, extend the terms they have to generate greater productivity and comply without problems with the economic commitments acquired.
conclusion
As we have seen throughout this post, the debt ratio of a company corresponds to an excellent financial product, which, managing it properly and responsibly, can represent an ideal tool for the economic management and financial solvency of a company over time. It also enables us to obtain resources in the form of long-term financial loans and credits, from various financial organizations, to quickly grow those businesses with sufficient potential, and always with the peace of mind that the payments and invoices of said debts can be covered. Without any problem, because that is exactly what we have to monitor the debt ratio that our company or business has.
Finally, it is a method to have control over loans, credits and debts, as resources that can be solved in a certain time, which enables us to develop the business without the hindrance of the lack of financing, and having the certainty that all the economic commitments acquired can be covered, without setbacks that may affect stability or the financial one. company health.
