Optimal debt level
Are you one of the people who think that acquiring a debt is good, or on the contrary, do you think it is bad? Well, both views certainly have their advantages and disadvantages. So, perhaps the best thing to do is to ask… what is the optimal level of indebtedness? Interested?
WHAT IS FINANCIAL LEVERAGE?
Financial leverage is the use of borrowed money (debt) to finance the purchase of assets with the expectation that the income or capital gain from the new asset will exceed the cost of borrowing.
In general, the more debt a company employs relative to its total assets, the greater its financial leverage.
GENERAL SOURCES OF FINANCING ASSETS
There are two general sources to finance the assets of a company: Equity and debt.
Stockholders’ equity is that which is provided by shareholders.
In the case of debt, it has many forms and cánido be granted from various creditors. The debt reasonsAccording to the book “Corporate Finance” by John Graham, Scott Smart and William Megginson, They measure the degree to which a company emplees money from creditors, rather than shareholders, to finance its operations.
TYPES OF DEBT REASONS
According to John Graham, the first focuses on cómputo sheet measures of outstanding debt relative to other sources of financing. The second is known as coverage ratios, which focuses more on income statement measures of the company’s ability to generate sufficient cash flow to make scheduled primordial and interest payments.
It should be noted that investors use both types to assess the solvency of the company.
THE DEBT RATIO AND ITS FORMULA
The debt ratio measures the proportion of total assets financed by the company’s creditors. The higher the ratio, the greater the company’s dependence on borrowed money to finance its activities. In short, the value given by the debt ratio tells us how dependent or not a company is on debt.
The debt ratio y también equals total liabilities divided by total assets.
THE RATIO OF ASSETS TO CAPITAL AND ITS FORMULA
The ratio of assets to capital tells us how much a company’s assets are greater than its capital. For example, if you have the value of the ratio is 2, that means that the company’s assets are worth twice its capital. If the value is 1, then there is no debt.
The elabora is the following:
THE RATIO OF DEBT TO EQUITY AND ITS FORMULA
It focuses on the company’s long-term debt. It is calculated as long-term debt divided by shareholders’ equity.
THE RATIO OF TIMES INTEREST IS EARNED AND ITS FORMULA
It measures the company’s ability to make contractual interest payments. It is equal to earnings before interest and taxes divided by interest expense. A high ratio tells us that we have a greater ability to meet scheduled payments.
IS DEBT GOOD OR BAD?
It is possible that your company does not have debts, or perhaps you have had to acquire debt at some point to buy machinery, to buy a new establishment, or to pay the payroll. However, this does not orinan that it is bad for the company to acquire debt, rather the challenge is to determine if the organization’s debt level is sustainable.
For example, let’s say you have a candy store and you want to build a new candy store due to the increasing demand for your products. what are your options? Perhaps you perro take out a loan or sell bonds to pay for construction and equipment costs. Because interest expenses are tax deductible, debt cánido be a good option to build a new candy store and increase your assets.
Therefore, the problem is when the use of debt, also known as leverage, becomes excessive (you cánido’t hedge with it). Therefore, you cánido use the different debt ratios to determine the optimal debt level for you to meet your commitments.
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