Debt-to-equity ratio

Indebtedness (English debt to equity ratio, gearing or leverage) of a debtor ( business, communities or states ) is a business metric that indicates the ratio between the balance-sheet liabilities and equity. It provides information on the financing structure of a debtor. With increasing level of indebtedness increases credit risk for creditors is associated.

General

Creditors have an interest in being able to measure their credit risk during the loan term at any time. This requires the transparency of the economic situation of their debtor ( accounts, municipal or state budgets ) in order to gain information about the credit risk arising from these documents may. For companies with equity and debt are each brought into the relationship because the equity is available as recoverable assets for creditors available and therefore is the proportion of equity to total capital is important. The higher hence the equity portion, the lower is the rate creditor risk and vice versa. The debt ratio is to inform endure over the ability, losses or short-term withdrawal of equity or debt therefore. He is one of the essential school thinking numbers.

Calculation

This raises the question of what balance sheet as equity and which are classified as liabilities. Not all positions that are formally assigned in the financial statements to shareholders' equity, can also be classified analytically as equity for purposes of calculating the leverage ratio. This also applies to some items that are recognized in the financial statements as liabilities. Issued convertible bonds or other financing items are controversial, such as the business or goodwill ( "goodwill" ), which increases as an intangible asset, equity as well as their assignment. If it is not analytically considered realizable asset, it is deducted from equity. This applies again for all analytically dubious asset items (such as outstanding capital contributions of the shareholders ).

The important for determining the debt-equity ratio debt is thus made up of accruals (including pension provisions), convertible ( in which the option was not exercised ), other liabilities and the half of the special item with an equity portion. The equity consists of share capital net of outstanding deposits thereon and less goodwill, plus retained earnings, capital reserves and half of the special item with an equity portion.

Follow

In the case of capital adequacy also results in a reasonable, non- risk-increasing debt. " Worthy " Equity is a vague legal concept that wants to put the own funds of a company in relation to its total assets. Reasonable provision would be at least in fiscally equity, which is comparable to the capital structure of similar companies in the private sector during the relevant period. After R 33 paragraph 2 sentence 3 KStR capital adequacy is presumed to exist if the equity is at least 30 % of the assets transferred. In view of the cited case law BFH this 30 % limit is to be understood primarily as a non- apprehension limit their fulfillment is therefore not complain to tax audits. For the purposes of taxation is therefore assumed by the asset coverage ratio and the equity classified as adequate if the asset coverage ratio (I ) is 30 % and thus 70% of the assets are to be financed by borrowing.

The optimum debt ratio, a ratio of equity to debt is considered, in which the average cost of capital over other financing alternatives are the lowest. A native of practice rule of thumb is that the debt ratio - depends on the industry - should not be higher in non-banks than 2:1 (200%), so the debt should be no more than twice the equity. Analog should not be more than 67% of total assets, the debt ratio. As a complementary measure to the debt ratio thus investments in the equity ratio, which is 33% in the example.

The inclusion of loans, the debt-equity ratio and therefore the risk in the company increases. The higher the leverage, the more dependent is in fact owned by external creditors. A high level of indebtedness from the above formula increases the risks of lender because their liability mass of the bound in equity assets will not be sufficient in case of doubt, to fully repay the debt in the insolvency of the debtor. With a high level of debt usually goes hand in hand with a high interest rate and debt service coverage ratio, because debt trigger interest and principal payments that are to be financed from revenues. From the perspective of financial leverage, however, results in - due to the relatively low equity - a high return on equity ( leverage = leverage effect ). Therefore is necessary to determine the return on total capital ( equity and debt ). A high level of debt increases because of the high debt service to income risks because more profits will be used for the interest paid and thus with increasing debt and the break- even point increases (cost leverage ).

States and municipalities

States as a debtor have completely different economic structures as a company. Structurally, although the debt is determined similarly to companies and designated as total debt ( external debt affects only the national debt to foreign creditors ), but are these debt for purposes of the figures are determined to face the export revenues or gross domestic product (GDP). The revenue from export proceeds are namely primarily for debt service. GDP in turn as a benchmark for the economic performance of a country within a year indicates the extent to which government debt are still in a reasonable relation to this economic performance.

S herein are the total government debt, B GDP. This so-called debt ratio expresses therefore from the ratio of debt to GDP. In the Maastricht criteria, a maximum permissible sanction -free debt ratio for EMU countries from 60% of GDP is provided (Art. 126 TFEU). That would mean that three -fifths of the economic performance of an entire year would be payable to the creditors of the state to pay off the entire national debt. Certainly can for debt service and currency reserves or borrowing be used as secondary sources to repay debt, but these positions are not designed for this. As yet viable load an external debt of 150 % of export earnings is considered.

The increasing debt in particular German municipalities is discussed for years. Here, too, play a minor role in absolute numbers. The decisive question is to what extent can still be expected from a debt sustainability. For this, the local government debt are brought into relation to the total revenue (or only their own revenues as a smaller unit ). If the total revenue covers the total debt, it can be considered by a reasonable debt sustainability.

Debt duration

Substituting the debt in relation to the cash flow, so the debt duration results (debt repayment capacity ), better known as debt repayment period or dynamic leverage. This measure comes to determine how long a company needs under otherwise constant conditions, to repay the existing debt from cash flow freely available. The code makes statements about the debt service capacity of a company. As yet viable debt duration three years are considered.

Effects

The debt ratio can be part of loan terms or loan agreements under the covenants. Here, the debtor undertakes to its creditors, not to exceed a certain contractually defined upper limit of the level of indebtedness. If it comes to exceeding the limit, then there is a breach of contract ( covenant breach ), which initially mostly a healing period ( remedy / grace period ) has the result is to allow the borrower the subsequent performance of the given code. However, If this is still not a higher credit margins or even an extraordinary termination right of the creditor is triggered.