Low Debt Ratio: How Does It Contribute to Company Performance?
Low Debt Ratio: How Does it Contribute to Company Performance?
Introduction
It has been said that you must measure what you expect to manage and accomplish. The same is true when one considers business performance. In a business measurement drives improvement which drives satisfaction. In turn, satisfaction results in loyalty from customers which means the financial success of a business. Without measurement, one has no reference to work with and thus, tends to operate in the dark.
One way of establishing references and managing the financial affairs of an organization is to use ratios. Ratios are simply relationships between two financial balances or financial calculations. These relationships establish our references so we can understand how well we are performing financially. Ratios also extend our traditional way of measuring financial performance; i.e. relying on financial statements. By applying ratios to a set of financial statements, we can better understand financial performance.
Statement of the Problem
The debt ratio compares a company 's total debt (the sum of current liabilities and long-term liabilities) to its total assets (the sum of current assets, fixed assets, and other assets such as 'goodwill '), which is used to gain a general idea as to the amount of leverage being used by a company. It compares the funds provided by creditors to the funds provided by shareholders and gives a quick measurement of the amount of debt that the company has on its balance sheet. As more debt is used, the Debt to Equity Ratio will increase. Since we incur more fixed interest obligations with debt, risk increases. On the other hand, the use of debt can help improve earnings since we get to deduct interest expense on the tax return. It is ideal to balance the use of debt and equity such that we maximize our profits, but at the same time manage our risk. It is said that companies with low debt ratios perform better than companies with high debt ratios.
Introduction
It has been said that you must measure what you expect to manage and accomplish. The same is true when one considers business performance. In a business measurement drives improvement which drives satisfaction. In turn, satisfaction results in loyalty from customers which means the financial success of a business. Without measurement, one has no reference to work with and thus, tends to operate in the dark.
One way of establishing references and managing the financial affairs of an organization is to use ratios. Ratios are simply relationships between two financial balances or financial calculations. These relationships establish our references so we can understand how well we are performing financially. Ratios also extend our traditional way of measuring financial performance; i.e. relying on financial statements. By applying ratios to a set of financial statements, we can better understand financial performance.
Statement of the Problem
The debt ratio compares a company 's total debt (the sum of current liabilities and long-term liabilities) to its total assets (the sum of current assets, fixed assets, and other assets such as 'goodwill '), which is used to gain a general idea as to the amount of leverage being used by a company. It compares the funds provided by creditors to the funds provided by shareholders and gives a quick measurement of the amount of debt that the company has on its balance sheet. As more debt is used, the Debt to Equity Ratio will increase. Since we incur more fixed interest obligations with debt, risk increases. On the other hand, the use of debt can help improve earnings since we get to deduct interest expense on the tax return. It is ideal to balance the use of debt and equity such that we maximize our profits, but at the same time manage our risk. It is said that companies with low debt ratios perform better than companies with high debt ratios.