$4$: Analysis of Financial Statements: Debt Management Ratios

Debt Management Ratios

Debt management ratios measure the extent to which a firm uses financial leverage and the degree of safety afforded to

$.$ They include the: $(1)$ Debt$-$to$-$capital ratio, $(2)$ Times interest earned ratio $($TIE$),$ and

the percentage of funds provided by

$.$ Its equation is:

$\frac{\text{T}\text{o}\text{t}\text{a}\text{l}\text{d}\text{e}\text{b}\text{t}}{\text{T}\text{o}\text{t}\text{a}\text{l}\text{c}\text{a}\text{p}\text{i}\text{t}\text{a}\text{l}}=\frac{\text{T}\text{o}\text{t}\text{a}\text{l}\text{d}\text{e}\text{b}\text{t}}{\text{T}\text{o}\text{t}\text{a}\text{l}\text{d}\text{e}\text{b}\text{t}+\text{E}\text{q}\text{u}\text{i}\text{t}\text{y}}$

High debt ratios that exceed the industry average may make it costly for a firm to borrow additional funds without first raising more $[$

income can decline before the firm is unable to meet its annual

$-$Select$-$

payments. Its equation is:

Times$-$interest$-$earned $(TIE)$ ratio $=\frac{\text{E}\text{B}\text{I}\text{T}}{\text{i}\text{n}\text{t}\text{e}\text{r}\text{e}\text{s}\text{t}\text{c}\text{h}\text{a}\text{r}\text{g}\text{e}\text{s}}$

EBIT is used as the numerator because

is paid with pretax dollars$-$the firm's ability to pay

is not affected by taxes. The EBITDA coverage ratio is:

EBITDA coverage ratio $=\frac{\text{E}\text{B}\text{I}\text{T}\text{D}\text{A}+\text{L}\text{e}\text{a}\text{s}\text{e}\text{p}\text{a}\text{y}\text{m}\text{e}\text{n}\text{t}\text{s}}{\text{I}\text{n}\text{t}\text{e}\text{r}\text{e}\text{s}\text{t}+\text{P}\text{r}\text{i}\text{n}\text{c}\text{i}\text{p}\text{a}\text{l}\text{p}\text{a}\text{y}\text{m}\text{e}\text{n}\text{t}\text{s}+\text{L}\text{e}\text{a}\text{s}\text{e}\text{p}\text{a}\text{y}\text{m}\text{e}\text{n}\text{t}\text{s}}$

This ratio is more complete than the TIE ratio because it recognizes that depreciation and amortization are not

expenses, so these amounts are available to service debt, and lease payments and principal

repayments are fixed payments.