Everybody should take stock of their financial position on a regular basis. Some people check their wallets or credit cards daily. But when you run a company, it’s not that simple. To evaluate your company’s financial situation, you need the net debt calculation that will show you the financial health of your business. Imagine that you own a company and that you have a percent of revenue from a new product or service idea, but you need money to make it a reality. The money can be withdrawn from a bank, but that will put you into a bigger debt with debt ratio. This calculation shows you if you can take another debt without affecting your profit.
This calculation is useful to know in other situations as well. In the era of many financial crises, this metric could help you predict certain scenarios if the market price were to go down. If the result of the calculation shows a bigger ratio, then the company has more debts than current assets and the fixed assets. If the ratio is smaller, then the company has enough resources to pay its debt faster.
To see exactly how this ratio works, you can take a look at the formula below.
Net Debt Formula and General Info
Before calculating the net debt ratio, bear in mind that you will need a current status of all the debts in the company– both long-term and short-term debts. When it comes to the long-term debts, you should know that they are to be paid in more than a year. So, whether you have loans due next year or in two years from now or pension funds, they all are long-term debts.
Next, you should take a look at the short-term debts. Obviously, these must be repaid in less than a year.
The first step in calculating the net debt is putting the long-term and short-term debts together. Next, you must add all the cash and cash equivalents from the company. A cash equivalent includes all the liquid assets of the company that are easily convertible into cash. The final step is to subtract the cash and cash equivalent sum from the long term and short-term sum. The equation will look like this:
Since all industries are financed differently, all of them have different ends. For example, an IT company will have a lower ratio because their services usually do not require large equipment, so the liquid assets are plenty to cover any expenses. Meanwhile a construction company will have a higher ratio because it works mainly with heavy equipment. Heavy equipment is also considered a liquid asset, but it cannot be sold to cover any debts because it is to be used on a daily basis.
Final Thoughts
Knowing where you stand financially is the most important aspect of a business. Tracking your debt could be a lifesaver if circumstances change or inspiration strikes if you deal in a careful and professional financial manner. Knowing your financial situation and calculating your net debt could end up meaning the difference between being bankrupt, and being successful.