Debt Management Ratios

 

Debt management ratio is a financial ratio which indicates the level of debt financing in an organization. Naturally an organization may not always have all the funds it needs to operate. So what it does is borrow from lenders for short term and fulfill its obligations. After this, it generates profit  from business and pays to these lenders in time. It is crucial to manage the level of debt financing because too much debt leads to too much interest payment. So it affects profitability. To mitigate this, a company makes a policy of borrowing only to certain percentage. Further, it also calculates several ratios to understand the situation of debt financing and decide accordingly. These ratios are as follows:

1. 1.       Debt Ratio: Debt ratio signifies the share of total debt in total assets. If the share is very high, then it can be trouble for a company because it leads to too much interest payment. Thus, the profit of company will shrink. Also, in such case creditors may not lend further. Therefore it creates trouble for the operation in a company.

Mathematically,

Debt ratio= Total Debt/ Total Assets

Naturally debt ratio shows the parts total debt comprises in total assets. So it gives an early warning to managers to stop financing by debt. Also it gives prior warning to investors to stop lending because a company may not be able to pay.

Example of Calculation

What is the debt ratio of a company with 100 million in total debt and 200 million total assets.

Solution;

Total Debt = 100 Million

Total Assets= 200 Million

Debt ratio= Total Debt/ Total Assets= 100 Million/200 Million = 1/2= 0.5

This ratio can be compared to company standards to determine whether the ratio is higher or not.

 

2.      Debt- Equity Ratio:  Debt equity ratio is the ratio of total debt to total equity. In calculating this, it shows the share of total debt in total equity. We add long term debt and current liabilities to determine the value of total debt. Whereas, total equity includes equity capital, preference share capital and undistributed profits. So debt-equity ratio shows the long term solvency position of a company.

The higher the debt equity ratio, the higher a company is debt financed. As explained in earlier topic, in such case an organization has to pay more interest and so its profits becomes low. If an organization takes huge loan, a very big amount needs to be paid as interest. Thus this situation should be avoided.

It is generally safer for an organization to increase shareholders equity. This is because they don’t have to pay interest on it and also it don’t affect profitability.

Mathematically,

Debt-Equity Ratio= Total Debt / Total Equity

For eg: Calculate the debt-equity ratio of a company having total debt 5 million and total equity of 20 million.

Solution;

Total debt= 5 million

Total Equity = 20 million

Debt-Equity ratio = 5 million/20 million =  0.25

This value should be compared to industry standards to determine if the ratio is higher or not.

 

3.      Long Term Debt to Total Assets Ratio: This is another measure of the solvency position of a company. It is calculated by dividing long term debt with total assets. It also indicates the leverage position of a company, but in case of long term debt and not in case of total debt.

Mathematically,

Long Term Debt to Total Assets Ratio= Long Term Debt/ Total Assets

For example: Calculate the long term debt to total assets ratio if the long term debt is 300 million and total assets is 400 million.

Solution,

Long term debt= 300 Million

Total Assets= 400 Million

Long term debt to total assets ratio = Long term debt / Total Assets= 300 Million/ 400 Million = 0.75

 

4.         Equity Multiplier: Equity multiplier is calculated as the ratio of Total Assets to Total           Equity. So it shows how much times total assets is greater than total equity.

           Mathematically,

           Equity Multiplier= Total Assets/Total Equity

           It can also be used to calculate debt ratio.

           Debt ratio= 1-1/Equity multiplier

           Thus if the equity multiplier is high, the debt ratio is higher. And if the equity multiplier                     is lower, the debt financing is lower.

           It becomes necessary to calculate equity multiplier because it shows how much                             percentage of total assets is financed by total equity.

           For Example: Calculate the equity multiplier if the Total Assets is 250 million and Total                    equity is 150 million.

           Solution,

           Total Assets = 250 million

           Total Equity= 150 million

            Equity Multiplier= 250 million/ 150 million= 1.66

            It shows total assets is 1.66 times total equity.

 

5.      Times Interest Earned Ratio:. As discussed earlier, a company manages its fund through debt financing and equity financing. It is crucial for a company to pay its annual interests because it creates credibility among lenders. Thus, times interest earned ratio is calculated to understand the ability of a company to pay its interest obligations. In this case, higher ratio indicates that a firm can pay its annual interest easily whereas lower ratio shows it will be difficult for a firm to pay its annual interest payment.

Mathematically,

TIE ratio = EBIT/ Interest Charges

For example: Calculate the TIE ratio if a company has EBIT of 100 million and Interest charges of 25 million.

Solution,

EBIT= 100 Million

Interest charges= 25 million

TIE ratio = 100 Million/ 25 Million = 4 times.

 

6.      Cash Coverage Ratio: It is the ratio of cash available in the firm to pay its borrowers to total interest charges. To calculate total cash available, we sum earning before interest and taxes with depreciation. This is because EBIT show the amount of cash available before payment of interest and taxes. Also depreciation is a provision and its cash amount is hold in a company. Thus they are cash reserves.

Higher ratio show that a company can easily fulfill its interest payment obligations and lower ratio shows a company will face difficulty to pay its interest obligations.

            Mathematically,

            Cash coverage ratio = EBIT+ Depreciation/ Interest charges

            For example: Calculate the cash coverage ratio if EBIT is 50 Million and depreciation is                              1 Million. Further the interest charges is 20 million.

            Solution,

            EBIT= 50 Million

            Depreciation = 1 Million

            Interest Charges= 20 Million

            Cash Coverage ratio = EBIT+ Depreciation/ Interest Charges = 50 mil + 1 mil/ 20 mil=                                                                                                          51/20 = 2.55

 

7.   Fixed Charge Coverage Ratio :  An organization leases its unused assets to other                        companies for earning. Further they also take assets on lease from other companies. Also            they have sinking fund payment associated with debt. Sinking funds are the funds that are            accumulated on regular intervals for payment obligations which may arise in the future.

      Mathematically:

Fixed Charge Coverage Ratio = EBIT+ Lease Payments

                         Interest Charge+ Lease Payments+ (Sinking fund payments/ 1- tax rate)

 

The higher the ratio, the better the capacity of an organization to pay its fixed charges. The lower the ratio, the difficult it is for a company to pay its fixed charges.

For Example: Calculate the Fixed charge coverage ratio of a company with EBIT 50 million, lease payments of 2 million, sinking fund payments of 0.5 million and tax rate off 30 percent.

Solution,

 EBIT= 50 Million

Lease Payment= 2 million

Interest charge= 10 million

Sinking funds payment = 0.5 Million

Tax rate= 30 Percent

 Fixed charge coverage ratio= (50+2)/(10+2+(0.5/1-0.3))= 52/(12+0.71) = 4.09 times

 

8.      EBITDA Coverage Ratio: It is the ratio of sum of EBITDA and lease payments divided by the sum of Interest, Principal Payments and Lease Payments. Generally this ratio is developed by Bankers to minimize the deficiencies of TIE ratio. While calculating this ratio, increasing ratio is considered favorable which shows the companies capability to pay the fixed charges.

Mathematically,

 EBITDA coverage ratio= (EBITDA+Lease Payments)

                                       ( Interest+Principal Payments+ Lease Payments).

 For eg: Calculate the EBITDA coverage ratio if EBITDA is 50 million, Lease payments   of 5 million, Interest of 2 million and principal payments of 1 million.

 Solution,

 EBITDA= 50 million

 Lease Payments= 5 Million

 Interest= 2 Million

 Principal payments= 1 million

 EBITDA= (50+5)/(2+1+5)=55/8=  6.875 times

 

Further Reads 

https://usefulfinanceforus.blogspot.com/2025/07/assets-management-ratio.html

https://usefulfinanceforus.blogspot.com/2025/07/profitability-ratios.html 

 

 

 

 

 

 

 

 

Assets Management Ratio

Assets Management Ratio

Assets management ratios are another important financial ratios. They are an indicator of how well a firm is

managing its assets. They are often named as activity ratios or efficiency ratios or turnover ratios. It is crucial for

 an organization to maintain schematic management of Assets because once assets are used, if it doesn’t produce 

profit, will result in loss. Such assets can be lost forever. Thus assets management ratios help in managing such

assets.

Types

1. Inventory Turnover ratio: It is defined as the ratio of Cost of Goods Sold and Average Inventory.  

   It measures the efficiency of utilization of inventory. 

 Inventory Turnover Ratio= Costs of goods sold/ Average Inventory

 Where, we get Cost Of Goods Sold by substracting Gross profit from Net sales.

 i.e Cost of goods sold= Net Sales- Gross Profit

When gross profit is deducted from Net sales, it shows how much the cost (Purchasing cost and production cost )

of goods were incurred. When divided by Average inventory, it shows the ratio of inventory that was sold.

A higher inventory turnover ratio is better because it shows that inventories is being managed very efficiently. A

low inventory turnover ratio shows more investment has been made in maintaining inventories relative to sales. A

higher inventory ratio means there will  be shortage of inventories most of the times and thus needs to be  properly

managed.

Inventory turnover ratio can also be used to find the age of inventory. i.e in how many days inventory is being 

cleared.

Mathematically,

Days of inventory (age of inventory) = Days in a year/ Inventory turnover ratio

2. Receivables turnover ratio: An organization doesn’t always work on direct payment. It works on 

   credit also. Thus receivables are created. Receivables is very important to maintain liquidity and 

   should be collected on time. For this purpose, Receivables turnover ratio shows the ratio of annual 

   sales and average debtors.

  Mathematically: 

Receivables turnover ratio= Annual Credit sales/ Average receivables or debtors

The higher the ratio, the more efficient a company is in the management of collection from debtors. A low ratio 

shows that a company is inefficient in collection.

3. Days sales outstanding (DSO): A company works in cash payment as well as in credit. It becomes crucial to 

collect debt in timely manner for smooth functioning of a company. Otherwise, a company may run short of cash

to pay for its daily needs. Thus to solve this issue, the Days Sales Outstanding is calculated. It calculates a 

company’s ability to collect debt timely. The lower the days sales outstanding, the better a company is collecting

its debts. Also the higher the DSO, the performance of the company in terms of debt collection is worst.

Mathematically,

DSO= Receivables/ Average Credit Sales per day

For example, If the receivables is Rs 500 and average credit sales per day is 50, then 

DSO= 500/50 = 10 days

It shows that the receivables is collected in 10 days. If the credit term is 10 days or lower, then the company is 

managing receivables effectively. But if the DSO is higher than 10, it shows that the company hasn’t been able to

manage receivables properly.

4. Fixed Assets Turnover Ratio: A company should use its fixed assets to generate sales. This helps a company

 to remain in business for a longer term. To find out if a company is utilizing fixed assets to generate sales 

properly, fixed assets turnover ratio is calculated. It is calculated by dividing Sales by Net fixed Assets.

Mathematically,

Fixed Assets turnover ratio = Sales/ Net Fixed Assets

Higher value of this ratio shows that a company is efficient in managing its assets. Whereas lower value shows 

that a company hasn’t been able to manage or make optimal use of its fixed assets. Thus it is one of the major 

factor in ratio analysis.

For example, if sales is Rs 50,000 and Net fixed assets is Rs 25000, then 

Fixed Assets Turnover Ratio= 50000/25000 = 2 

But if sales is Rs 50,000 and Net Fixed Assets is 30,000, then

Fixed Assets Turnover Ratio= 50000/30000= 1.66

 

In conclusion, it shows that the company having Fixed Assets Turnover ratio of 2 is performing better than that 

of the company having ratio of 1.66.

5. Working capital turnover ratio: The working capital turnover ratio calculates how the working capital of a

 firm has been utilized. The working capital is calculated as Total Current Assets less Total Current Liabilities. 

Thus it is the excess value of Current Assets which can be used for other purposes.

Mathematically,

 Working capital turnover ratio = Annual net sales/ Average working capital

It is to be noted that, in the above formula, for higher value of working capital turnover ratio, the value of average

working capital should be lower. Thus, it shows that there is lower investment in working capital and the 

profitability becomes higher. In other case, if there is more investment in working capital, the value of average 

working capital will be higher and the working capital turnover ratio will be lower. Thus, it reflects 

mismanagement.

6. Total Assets Turnover ratio: This ratio shows how a company is utilizing its Total Assets. To calculate this 

ratio we should divide Sales by Total Assets.

 

Mathematically,

Total Assets Turnover Ratio= Sales/ Total Assets

Total Assets is calculated as the sum of Current Assets, Fixed Assets and Investment. Thus the above ratio shows

 how much greater sales is being generated in comparison of assets being employed. The value of this ratio is 

better if it is higher than one because it shows that a company is generating enough sales. A low ratio means a 

company is not performing better.

 

Further Reads 

 

https://usefulfinanceforus.blogspot.com/2025/07/debt-management-ratio-analysis.html

 

https://usefulfinanceforus.blogspot.com/2025/07/profitability-ratios.html 

Financial Ratios and Analysis

Financial analysis is the analysis of financial statements for decision making purposes. Financial statements serves 

dual purpose: First it’s used to evaluate a company’s performance by internal staffs. Secondly it’s used to evaluate 

the performance of company by outsiders. Internal staffs appraise financial indicators to improve the performance

 of a company whereas external people evaluate financial indicators to decide for investment. If the financial ratios 

are promising, investors will be willing to invest in a company.

For internal control process, the relationship between financial statements(Income Statement, Balance sheet and 

Cash Flow Statement) should be evaluated. Additionally financial ratios should also be evaluated. Together these 

statements serve as an indicator of performance of a company. Also they serve as a benchmark about how

 competitors are performing in the market. If the ratio is higher, then it may mean that the competitors are doing 

better and vice versa. Thus a company gets a chance to improve itself in time.

Financial ratios are the major tool of financial analysis. They help to find out the systematic strength or weakness 

of a company. Thus they are highly important.

Financial ratios can be grouped into following five types:

1. Liquidity ratios

2. Assets management or efficient ratios

3. Debt management ratio or leverage ratios

4. Profitability ratios

5. Market value ratios

We will now deal one by one with these ratios. Firstly we will understand about liquidity ratios.

 

1.  Liquidity ratios: Liquidity ratios are the major part of financial ratio analysis.The purpose of these ratios is to 

find out the solvency position of an organization. This means whether a company is able to pay its short term 

liabilities or not. Being able to pay short term liabilities is crucial for an organization because it helps to build an 

environment of trust in the eyes of investors. This is important for the smooth running of an organization. The major 

liquidity ratios are:

 

 1.a) Current ratio: Current ratio is one of the major financial ratios. It measures the extent to which current 

liabilities is met by current assets. It is calculated by dividing current assets by current liabilities. Current assets are 

liquid and they can generate money in a relatively short period of time. Thus if the ratio of current assets with current 

liabilities is maintained, it becomes easier for payment. The major current assets are cash, Marketable securities, 

saundry debtors, bills receivable and inventory. The major current liabilities are bank overdraft, saundry creditors, 

bills payable and outstanding expenses.

 But one thing we should be careful about! If current ratio is too high, it means a company is inefficient and 

misutilizing its fund in purchasing too much current assets. But if the ratio is too low, then a company can’t fulfill 

its short term obligations. The standard ratio of current assets can vary country-wise but generally a current ratio of

 2:1 is considered best.

Mathematically: Current ratio = Current Assets/ Current Liabilities

1.b) Quick or Liquid or Acid Test Ratio: The purpose of this ratio is to find out the capacity of a company for

 immediate payment of current liabilities.Thus Quick ratio is calculated by deducting inventories from current assets 

and dividing by current liabilities. Inventories are deducted because it can be difficult to liquidate them at their full

 book value, thus rendering them invaluable for payment of current liabilities.

Mathematically, Quick Ratio= (Current assets- Inventories)/ Current liabilities

We can summarize as:

1. The ratio of 1:1 is considered as an ideal ratio for meeting all current liabilities.

2. The ratio greater than 1:1 indicates that a company is in strong position to fulfill its payment 

   liabilities.

3. The ratio less than 1:1 indicates that a company isn’t in position to fulfill its short term obligations.

Quick ratio is important for investors and managers because it provides a more clear view of liquidity position than 

that of Current Ratio.

1.c) Cash Ratio: This ratio gives an idea whether the most liquid assets can cover the current liabilities. These liquid 

assets are cash and marketable securities. Thus its formula is:

Cash ratio= (Cash + Marketable securities)/Current Liabilities

Cash denotes free cash level which can be easily paid to fulfill liabilities. Whereas Marketable securities can easily 

be sold in the stock market to convert them into cash within a short time frame of one year. Thus when the ratio is 

calculated by comparing current liabilities with cash plus marketable securities, it shows the chances of payment of 

current liabilities.  

• A cash ratio of greater than one means that a company is in better position to pay all of its current 

  liabilities.

• A cash ratio less than one means a company may face difficulties in paying its current liabilities.

1.d) Net Working Capital (NWC) to Total Assets Ratio: It is the ratio of net working capital and total assets. Net

 working capital is defined as the difference of current assets and current liabilities.

Thus first it shows how much the current assets is higher than current liabilities. Secondly it shows the ratio of this 

difference with respect to total assets.

Mathematically: NWC to total assets ratio= Net working capital/ Total Assets

                                                                  = (Current Assets-Current Liabilities)/ Total Assets

• Positive value of NWC to total assets ratio indicates that a company is in good position to pay its 

  current liabilities.

• Higher value of NWC to total assets mean that there is high chances that the short term obligation 

  be met

• Lower value of NWC to total assets mean that there is less chance that the short term obligation 

  be met.

• Negative value indicates that there will be difficulty to met the short term obligations.

Together Financial ratios are a major part of financial planning and analysis. They help in performance analysis as 

well as investment analysis. Thus they are used extensively for interpretation purpose.

 

Further Reads

https://usefulfinanceforus.blogspot.com/2025/07/assets-management-ratio.html

https://usefulfinanceforus.blogspot.com/2025/07/debt-management-ratio-analysis.html 

https://usefulfinanceforus.blogspot.com/2025/07/profitability-ratios.html 

 

 

PE Ratio

PE ratio is one of the major ratio which is used to analyze the performance of a company.

It's formula is:

PE ratio= Stock price/ Earning per share

As we can see, the formula of PE ratio summarizes to the excess of stock price in comparison to the earning per share. For example if the price of stock is $100 and earning per share is $50, then the PE ratio is:

PE ratio= Stock price/ EPS = $100/$50 = 2

In analyzing shares, higher PE ratio can mean a company is performing good but it can also mean that the share is overpriced. An investor should analyze the market to understand the value of PE ratio which is good for investment.

Let us take some examples:

• As of the latest data (June 21, 2025), Alphabet Inc. (Google) trades at a trailing P/E of about 16.9×, based on a price of roughly $166.64 and an EPS of $9.15.
• The Trailing Price‑to‑Earnings ratio of Meta is currently about 27.2× as on 21/06/2025.

Analyzing these two stocks clearly shows that it is not necessary that higher PE ratio mean risky shares. It depends on the overall performance of the company.

 

Factors that affect PE ratio

1.     Earning performance of a company: If the earning of a company is high, the PE ratio is less and if the earning of a company is low, the PE ratio is high. Thus we should carefully evaluate the earning of a company while deciding to invest.

 

2.     The price of stocks: An increasing price of stocks increases the PE value and vice versa. This is because as the formula suggests, if the numerator value is higher, the overall value of the ratio is higher.

 

3.     Growth expectations: Companies which are expected to grow in the future have higher PE ratio. This is because the prices of such stocks increases in expectation that their future profits will increase.

 

4.     Risk and Volatility: Higher risky products have lower PE ratio because people are less willing to invest in such stocks.i.e they demand higher return for risk taken. This lowers price and as a result PE ratio decreases.

 

5.     Market Interest rates: If the market interest rate is high, the discounted EPS of a company lowers. This also affects the price of stocks. Thus the PE ratio is low. And if the market rate is lower, the discounted EPS is higher and as a result, the PE ratio is higher. Also the borrowing capacity of investors increase if the market interest rate is low. This increases price of stocks because of higher investing capacity and the PE ratio increases. The same is true for vice versa.

 

6.     Market sentiment and  Investor Behavior: If the market sentiment is bullish, the investor behavior is to increase investment in a stocks. Subsequently the price of stocks increase and thus the PE ratio increases. And if the sentiment in the market is bearish, the price of stocks decrease in anticipation of loses. Thus the PE ratio decreases.

 

7.     Company risk and stability: If the risk of a company is high or cyclical, it decreases PE ratio. This is because investor invest less in anticipation of loses. But in low risk and stable companies, investor estimate profits and the price of stocks is high. Thus the PE ratio is higher.

 

8.     Inflation and Economic conditions: If inflation is high, the purchasing power of investor lowers. As a result, the price of stocks lowers. Also in such economic conditions the profit of companies lowers. Thus PE ratio become lower. The vice versa is true for when the inflation is lower.

 

9.     Debt Levels: If a company operates in higher debt level, then it experiences lower earning per share. This is because the majority of income goes in payment of interest of debt. Thus the price of such stocks also lower because investor anticipate lower returns in terms of dividend and bonus share. Thus PE ratio becomes lower.

 But if the debt level is lower, the EPS becomes higher. The price of such stocks increases because investors can get higher return and thus the PE ratio increases.

 

10.  Dividend Policy: The companies which pay higher dividend may have lower P/E Ratios because they return cash to shareholders instead of reinvesting for growth. Thus their future profits decrease. Thus can also lower their share value. As a result the PE ratio becomes lower.

            But the companies which focus on growth and pay less dividend have higher PE ratios because                  they earn more by reinvesting. Thus the earning per share also increases as well as the price of                    stocks also increase.

 

 

 

 

 

 

 

Evaluate Value stocks and Growth Stocks

 Evaluate Value Stocks

Value investors do not base their investment decisions on hot tips, the latest investment trends, or chart patterns. Instead, they base their decisions on deep quantitative and qualitative research. Value investors spend time analyzing companies financials and pay particular attention to valuation ratios such as the price to earnings(P/E) ratio, the price to book (P/B) ratio and the free cash flow (FCF) ratio. They also often use discounted cash flow(DCF) models to determine whether a company is undervalued by the market. They like stocks that offer a significant 'margin of safety-those trading well below their true value.

Evaluate Growth Stocks

Growth stocks are simply evaluated as the present value of cash flows expected in the future. If we expect an stock to return $100, $200 and $300 in the coming first, second and third year, then the present value calculation of all these returns is its overall value.

 For more Finance Concepts, be in touch with this blog.