Everybody must know and check their financial situation on a regular basis. Some people check their wallets or credit cards daily. But when you rule over a company, it’s not that simple. For this, you need the net debt calculation that will show you the financial situation and health of your business. Imagine that you own a company and that you have a new product or service idea, but you need money for that. The money can be withdrawn from a bank, but that will put you into a bigger debt. This calculation shows you if you can take another debt without affecting your profit.
Also, in the era of many financial crises, the result could predict certain scenarios if the market price goes down. If the result of the calculation shows a bigger ratio, then the company has more debts than current 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 debts, 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. As a matter of fact, 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. But a construction company will have a higher ratio because it works mainly with heavy equipment. The point is that 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
To conclude the above statements, knowing where you stand is the most important aspect of a business. Also, tracking your debt could be a lifesaver when dealt carefully and in a professional manner. Basically, it can mean the difference between being bankrupt and being successful.