INSUBCONTINENT EXCLUSIVE:
Debt is an important source of funds for a company especially when it operates in a capital intensive sector such as construction, metals,
However, it becomes a major concern when the business is no more profitable enough to pay for the interest or principal or both
This is evident from the recent bankruptcy filings of several companies with the National Company Law Tribunal
external commercial borrowings
Does that mean higher the debt, better it would be for profitabilityNot really
The ability of debt to gear up profitability ratios depends upon the efficiency of operations
What are the tools to find out the extent of indebtednessThere are several financial tools called as leverage ratios that investors can use
The debt-equity (D/E) ratio is among the most popular leverage ratio
A ratio above one indicates that the company is using more debt to finance growth.
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What is the degree of financial leverage (DFL)DFL is calculated as the ratio of earnings before interest and tax (EBIT) in the numerator and
EBIT less interest in the denominator
What are interest coverage and debt/EBITDA ratiosInterest coverage is obtained by dividing EBIT by interest outgo
A ratio below or close to one reflects that the company may struggle to pay interest in the near term
Debt/EBITDA reflects the number of years it would take the company to repay principal through operating profit before depreciation (EBITDA)
A higher ratio reflects longer period of repayment, which may discourage lenders from issuing fresh loan.
