Video Transcript: Debt Management Ratios

Hello, welcome. We're going to discuss debt management ratios. Debt  Management ratios are computations that use that are used to measure a  company's ability to pay its long term debt obligations, payables, turnover. We're going to calculate these right payables turnover, Age of payables, debt to  assets, debt to equity, and times interest earned. So we'll define these, we'll  work through some examples, and you'll understand more of how we use debt  management ratios. So let's dive in. Right payables, turnover. Okay, this  represents the number of times a company can pay its Accounts Payable during a period. So payable is we buy from a supplier some raw materials, let's say  anything that's going to be an input into our operation. We buy this on credit, like I've mentioned before, payment terms can be 15, 30, 45, 60, days, typically, 90  days, in some cases, maybe 120 just depends on your relationship with your  supplier. So this is those are accounts payable. So we're borrowed where we  are buying goods, raw materials, inputs into our operation on credit. So our cost  of goods sold is divided by the accounts payable. So cost of goods sold is  anything that goes into working capital, is anything that goes into the product  development in the actual operation involved in assembling the product, putting  it together, marketing, all of those things are in cost of goods sold. So we want  to make sure that we can pay our accounts payable based off of cost of goods  sold. Right? So let's dig in cost of goods sold for company. A in this example  was a million dollars. It's divided by accounts payable. In this example, accounts payable, payable is 506,000 so we'll divide this, and we're going to get 1.97  times so we can cover our accounts payable based off of cost of goods sold. So  that's an idea of working capital. We're going to be able to assume that this will  be our inventory finished products. How many times are our cost of goods sold  going to be able to pay for our accounts payable? So 1.97 times. So it's good  ratio, almost two times. You know, we can pay off our accounts payable with our  cost of goods sold almost by two times. So we're in good strength and position  there age of payables. So age of payables measures the average number of  days spent before paying obligations to suppliers. So we want to know how long is it taking us to pay back our payables. Curious of the terms, right? We want to  know how many times we are turning over our payables, right, and how quickly  are we paying them back, right? So, so payable turnover ratio allowed us to see  how many times we were flipping over our cost of goods sold, our cost of goods  sold and paying off our payables. We're flipping our cost. We're flipping our  working capital. We're flipping our inventory 1.97 times in order to pay for our  accounts payable. So here we're going to calculate the age of the payables.  How long is it taking us to pay back the credit terms? So age of payables, days  and years. So obviously, 365 days, we're going to divide that by account,  payable, turnover, 1.97 times. 1.97 times. So it's taking us we have to turn over  our inventory, inventory two times before we can pay for our accounts payable.  So now we're wanting to see how many days on average is it taking us to pay 

back our payables. So with this equation 365, divided by 197, 1.97 we are  paying back our payables in 185 days. That's a long time. We need to get that  reduced down so we can get better credit terms, debt to asset ratio, the long  term solvency and the capital structure for a company is being judged by the  debt to asset ratio. It shows the percentage of debt in comparison to the assets  of a company. It examines how many assets of a company are financed by debt. So we obviously want to have a lower debt to asset ratio. Let's figure this out so  total debt, right? Total debt, current liabilities, 543 plus long term debt, 531 we're going to divide that by total assets, in this case, 3373 right? So we're going to  have so out of our total assets, right? So this equals 1074, 543, plus 541, 1074  divided by 3373 this is going to give us 31.84% so this 31.84% tells us how  much of our assets are financed by debt. 31 almost 32% of our assets are  financed by debt. That's good. That's actually a really good ratio. We're less than 50 and we probably have a little room to take on a little more debt if we needed  to debt equity ratio. Debt equity ratio measures the long term solvency and the  capital structure of a company and helps in figuring out the percentage of debt  and equity in the balance sheet of a firm. A greater percentage of shareholders  equity shows access of finance, which safeguards the company's leverage. Debt equity ratio equals total debt or liabilities divided by the equity. Okay, debt to  equity ratio. Okay, so we're going to look at our total equity. Total equity is 2299  our current liabilities, 543 plus our long term debts. 531 so we're going to look at this and say 1074, divided by 2299 this is going to give us 46.72% so This tells  us that we have 46.72% of our capital structure is debt and the rest is equity. So  if we do 100% of the pie, subtract out the 46.72 that's how much debt that we  have. 53.28% of our capital structure is equity. So we have 46.72% is debt.  53.28% is equity. We're in a pretty good ratio here. Our equity is greater than our debt, which is always good, and we are actually developing a greater and  greater cash position. times interest earned so earnings before interest and  taxes. You'll often hear that being called EBIT. It's found on the income  statement as the net operating profit before subtracting interest expense and  taxes, measuring the ratio of the operating profit available to serve as debt. The  higher the number, the greater the safety margin, and the lower the risk a  company can pay its debts. Okay, let's look at this so earnings before interest in  taxes, EBIT, 691 Okay, our interest expense is 141 so our times interest earned,  so this is the ratio of the operating profit available to service debt. So this is our  this is our profit earnings before interest and taxes. EBIT is our revenues minus  our costs before the interest in taxes. So we haven't paid our we haven't paid  our interest payments yet. We haven't paid our taxes yet, right? So we want to  know how much of or how many times can our revenues before interest and  taxes cover our entire interest expense. So we'll be able to pay out interest out  of this revenue before interest and taxes figure. So we want to see how many  times we can cover our interest payments, right? So 691 divided by 141 is 4.9 

so we can cover our interest expense with our earnings before interest and  taxes, 4.9 times. And remember, the higher the number, the greater the safety  margin, and the lower the risk a company can pay its debt.