Leverage Ratio: Debt Equity Ratio and Debt to Total Capital Ratio
Arjun EP
Leverage Ratio
Leverage ratios are also known long-term solvency ratios and capital structure ratio.
These ratios show the ability of the company to meet its long term repayment.
These ratios represent the relationship between debts and equity (long term debt and shareholders’ equity).
It also measures borrowing capacity of the company. Under this method, following ratios are calculated:
Debt equity ratio
Debt to total capital ratio
Interest coverage ratio
Fixed coverage ratio
DEBT EQUITY RATIO
It is also called debt to net worth ratio.
It measures the relative claim of long-term loan and owners of the company.
Owners (shareholders) want to more debt to finance from outsiders investors but investors want to more investment from owners.
Its standard ratio is 1: 1.
Long-term loan or debts
Long-term debt and long-term loan have more than one year maturity period.
There are mid-term, long-term and very long-term period.
These loans and debts are:
|
Debentures |
Long-term loan |
Debentures premium |
|
Mortgage loan |
Bank loan |
Deferred tax |
Keep in Mind (KIM)
|
Debentures are issued by limited company. |
|
|
But bonds are issued by government and semi-government. |
|
|
|
|
|
Total debts = Long-term debts + short-term debts |
|
|
But all current liabilities are NOT added or considered with short-term debts. |
|
|
|
|
|
Considered debts: |
Non-considered debts: |
|
Long-term debts |
Account payable |
|
Bank loan |
Bank overdraft |
|
Bonds payable |
Bills payable |
|
Notes payable (maturity within a year) |
Creditor |
|
Drawn line of credit |
Outstanding expenses |
|
Current portion of long-term debt |
Accrued expenses |
|
Capital lease obligation |
Dividend payable |
|
|
Tax payable |
|
|
Deferred revenue |
|
|
Advance income |
|
|
|
Shareholders’ Equity, Shareholders Fund, Permanent Capital, Net Worth
|
Equity shares |
Retained earning |
Less: |
|
Preference shares |
Profit and loss (Cr) |
Preliminary expenses |
|
Share premium |
Dividend equalization fund |
Profit and loss (Dr) |
|
Share forfeiture |
Sinking fund |
Underwriting commission |
|
Capital reserve |
Compensation fund |
Loss on issue of debentures |
|
General reserve |
Investment fund |
Discount on issue of debentures |
|
Reserve and surplus |
|
|
Formula of debt equity ratio
|
Debt equity ratio (DER) |
= |
(Long-term debts ÷ Shareholders’ equity) x 100 |
|
Or |
= |
(Total debts ÷ Shareholders’ equity) x 100 |
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country
PROBLEM: 2A
The following information is given by Set Max Company Ltd:
|
Equity shares of Rs 100 each |
10,00,000 |
|
Profit and loss Cr |
190,000 |
|
|
8% Preference shares Rs 100 each |
640,000 |
|
Bank overdraft |
80,000 |
|
|
Reserve |
208,000 |
|
Creditors |
80,000 |
|
|
10% Debentures |
640,000 |
|
Outstanding expenses |
64,000 |
|
|
8% Long term loan |
800,000 |
|
Preliminary expenses |
40,000 |
|
|
Notes payable (maturity this year) |
120,000 |
|
|
|
|
Required: (a) Long-term debt; (b) Shareholders’ equity; (c) Total debts; (d) Debt equity ratio
[Answer: LTD = Rs 15,60,000; SHE = Rs 19,98,000;
TD = Rs 15,60,000; DER = 72.1% or 78.1%]
SOLUTION:
Given and working note:
|
(a) Long-term debt: |
|
(b) Shareholders’ equity: |
||
|
Debentures |
640,000 |
|
Equity shares |
10,00,000 |
|
Long term loan |
+ 800,000 |
|
Preference shares |
6,40,000 |
|
|
14,40,000 |
|
Reserve |
2,08,000 |
|
|
|
|
Profit |
1,90,000 |
|
|
|
|
Less: Preliminary expenses |
(40,000) |
|
|
|
|
|
19,98,000 |
|
(c) Total debts: |
|
|
(d) Debt equity ratio (DER) |
|
Long-term debts |
14,40,000 |
|
= (Long-term debts ÷ Shareholders equity) x 100 |
|
Notes payable |
+ 1,20,000 |
|
= (14,40,000 ÷ 19,98,000) x 100 |
|
|
15,60,000 |
|
= 0.721 x100 |
|
|
|
|
= 72.1% |
|
|
|
|
|
|
|
|
|
Alternatively, |
|
|
|
|
Total debt equity ratio (TDER) |
|
|
|
|
= (Total debts ÷ Shareholders equity) x 100 |
|
|
|
|
= (15,60,000 ÷ 19,98,000) x 100 |
|
|
|
|
= 0.781 x100 |
|
|
|
|
= 78.1% |
#####
|
Click on link for YouTube videos |
|
|
Accounting for Share |
|
|
Share in Nepali |
|
|
Debentures |
|
|
Final Accounts: Class 12 |
|
|
Final Accounts in Nepali |
|
|
Work Sheet |
|
|
Ratio Analysis (Accounting Ratio) |
|
|
Fund Flow Statement |
|
|
Cash Flow Statement |
|
|
Theory Accounting Xii |
|
|
Theory: Cost Accounting |
|
|
Cost Accounting |
|
|
LIFO−FIFO |
|
|
Cost Sheet, Unit Costing |
|
|
Cost Reconciliation Statement |
|
#####
Debt to total capital ratio
It helps to establish link between total capital and long-term debts.
Low ratio represents security to outsider investors for extending investment.
High ratio is risk for investors.
Very low ratio shows that managing directors are not using funds properly.
Its standard ratio is 2:3.
It means there should be 40% loan and 60% capital.
Formula of debt to total capital ratio
|
Debt to total capital ratio (DTCR) |
= |
Long-term loan ÷ Capital employed |
|
Or |
= |
Long-term loan ÷ Total capital |
|
Or |
= |
Total debts ÷ (Permanent capital + current liabilities) |
Keep in Mind (KIM)
|
Total capital |
= long term debt + shareholder equity |
|
Total capital |
= fixed assets + working capital |
|
Total debts |
= long term debt + current liabilities |
|
Capital employed |
= shareholders equity + long term loan |
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country
PROBLEM: 2B
The following extracted information is given:
|
Equity shares of Rs 100 each |
20,00,000 |
|
Reserve and surplus |
10,00,000 |
|
9% Preference shares of Rs 100 |
10,00,000 |
|
Current liabilities |
8,00,000 |
|
10% Debentures |
30,00,000 |
|
Loan from NB Bank |
20,00,000 |
Required: (a) Long-term debt’ (b) Shareholders equity; (c) Capital employed; (d) Debt to total capital ratio
[Answer: LTD = 50,00,000; SHE = Rs 40,00,000;
CE = Rs 90,00,000; DTCR = 55.6%]
SOLUTION:
Given and working note:
|
Long-term debt: |
|
Shareholders’ equity: |
|
|
10% Debentures |
30,00,000 |
Equity shares |
20,00,000 |
|
NB Bank loan |
20,00,000 |
Preference shares |
10,00,000 |
|
|
50,00,000 |
Reserve and surplus |
10,00,000 |
|
|
|
|
40,00,000 |
|
Capital employed: |
Amount |
Debt to total capital ratio (DTCR) |
|
Shareholders’ equity |
50,00,000 |
= (Long-term loan ÷ Capital employed) x 100 |
|
Long-term debts |
40,00,000 |
= (50,00,000 ÷ 90,00,000) x 100 |
|
|
90,00,000 |
= 0.556 x 100 |
|
|
|
= 56.6% |
Interest coverage ratio
It is also called total interest earned ratio and debt service ratio.
If the company has taken loan from outsiders, company has to pay interest on loan.
To pay interest, profit must be earned.
Loan providers want higher rate of interest.
If the company earns less profit, it cannot pay principal amount and interest within time.
Standard time is six to seven folds or times.
Formula of interest coverage ratio
|
Interest coverage ratio (ICR) |
= |
(EBIT ÷ Interest charge) x 100 |
|
Total interest earned ratio (TIER) |
= |
[(EBIT + Interest charge) ÷ Interest charge] x 100 |
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country
PROBLEM: 2C
The extracted data is available:
Earnings after tax (EAT) $/₹/Rs 600,000
Interest expenses/charge $/₹/Rs 100,000
Tax paid $/₹/Rs 150,000
Required: (a) Earnings before interest and tax; (b) Interest coverage ratio
[Answer: EBIT = Rs 350,000; ICR = 3.5 times]
SOLUTION:
(a) Earnings before interest and tax
|
EBIT – Interest – Tax |
= |
EAT |
|
EBIT – 100,000 – 150,000 |
= |
600,000 |
|
EBIT |
= |
350,000 |
(b) Interest coverage ratio (ICR) = (EBIT + Interest) ÷ Interest = 350,000 ÷ 100,000 = 3.5 times
###########
|
Click on link for YouTube videos: |
|
|
Accounting Equation |
|
|
Basic Journal Entries in Nepali |
|
|
Basic Journal Entries |
|
|
Journal Entry and Ledger |
|
|
Ledger |
|
|
Subsidiary Book |
|
|
Cash Book |
|
|
Trial Balance & Adjusted Trial Balance |
|
|
Bank Reconciliation Statement (BRS) |
|
|
Depreciation |
|
|
Final Accounts: Class 11 |
|
|
Adjustment in Final Accounts |
|
|
Capital and Revenue |
|
|
Single Entry System |
|
|
Non-Trading Concern |
|
|
Government Accounting |
|
|
Goswara Voucher (Journal Voucher) |
|
###########
Fixed charge coverage ratio
When company earns more profit, it can pay interest on loan, preference dividend and repayment of debt/loan within the time.
More ratios indicate that company has better position to pay loan and interest.
Formula of fixed charge coverage ratio
|
Fixed charge coverage ratio (FCCR) |
= |
EBIT ÷ Fixed charge |
Where:
Fixed charge = interest + preference dividend + repayment of loan
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country
PROBLEM: 2D
Following extracted data are given to you:
|
|
Amount |
|
|
Earnings before interest and tax |
5,00,000 |
|
|
10% Debentures |
10,00,000 |
|
|
8% Preference shares |
5,00,000 |
|
|
Repayment of debentures |
2,00,000 |
|
Required: Fixed charge and fixed charge coverage ratio
[Answer: FC = Rs 340,000; FCCR = 1.47 times]
SOLUTION:
Total Fixed charge
|
Interest on loan |
10,00,000@10% |
= |
100,000 |
|
|
Preference dividend |
500,000@8% |
= |
40,000 |
|
|
Repayment of debentures |
|
= |
200,000 |
|
|
|
Fixed charge |
= |
340,000 |
|
(b) Fixed charge coverage ratio (FCCR) = 500,000 ÷ 340,000 = 1.47 times
#####
|
PROBLEMS AND ANSWERS |
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country
PROBLEM: 2A
Following data are taken from XYZ Company Ltd (amount is $/₹/Rs):
|
Equity shares capital |
6,00,000 |
|
General reserve |
60,000 |
|
Profit and loss |
1,00,000 |
|
12% Debentures |
3,00,000 |
|
Sundry creditors |
50,000 |
|
Outstanding expenses |
10,000 |
|
8% Loan |
1,00,000 |
|
Preliminary expenses |
20,000 |
|
9% Mortgage loan |
1,30,000 |
|
|
|
Required: (a) Debt equity ratio; (b) Debt to total capital ratio
[Answer: DER = 71.62%; DTCR = 41.73%]
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country
PROBLEM: 2B
Following data are taken from XYZ Company Ltd (amount is $/₹/Rs):
|
Equity shares capital |
6,00,000 |
|
General reserve |
60,000 |
|
Profit and loss |
1,00,000 |
|
12% Debentures |
3,00,000 |
|
Sundry creditors |
50,000 |
|
Long-term public deposit |
1,00,000 |
|
Discount on shares |
20,000 |
|
9% Preference shares |
2,00,000 |
Required: (a) Debt equity ratio; (b) Debt to total capital ratio
[Answer: DER = 42.55%; DTCR = 29.85%]
***** #EPOnlineStudy *****
Thank you for investing your time.
Please comment on article.
You can help us by sharing this post at your social media platform.
Jay Google, Jay YouTube, Jay Social Media
जय गूगल, जय युट्युब, जय सोशल मिडिया
You might also like
Income Statement under NFRS | Balance Sheet under NFRS | P&S 1
Balance Sheet under NFRS | Statement of Financial Position under NFRS | Solution
Income Statement under NFRS | Profit or Loss Statement under NFRS | SOLUTION
Income Statement under NFRS | Balance Sheet under NFRS | EXPLANATION
Financial Statement under NFRS| Classification of Accounting Standards
Swar | Vyanjak | A Aa I Ee | Ka Kha Ga Gha | Ka Kaa Ki Kee | Barahkhadi | Kra Khra Gra
ABCD | British Phonetic ABCD | American Phonetic ABCD | ABCD in Devanagari
The Half-closed Eyes of the Buddha and the Slowly Sinking Sun | All Solution | NEB English Class 12 | Short Story Q&A
Comment box closed