Debt management ratios measure the extent to which a firm uses financial leverag

Question

Debt management ratios measure the extent to which a firm uses financial leverage and the degree of safety afforded to . They include the: (1) Debt-to-assets ratio, (2) Times interest earned ratio (TIE), and (3) EBITDA coverage ratio. The first ratio analyzes debt by looking at the firm's , while the last two ratios analyze debt by looking at the firm's . The debt-to-total-assets ratio measures the percentage of funds provided by . Its equation is: High debt ratios that exceed the industry average may make it costly for a firm to borrow additional funds without first raising more . The times interest earned ratio measures the extent to which income can decline before the firm is unable to meet its annual payments. Its equation is: EBIT is used as the numerator because is paid with pretax dollars—the firm's ability to pay is not affected by taxes. The EBITDA coverage ratio is: This ratio is more complete than the TIE ratio because it recognizes that depreciation and amortization are not expenses, so these amounts are available to service debt, and lease payments and principal repayments are fixed payments.

Explanation / Answer

The first ratio analyzes debt by looking at the firm's balance sheet , while the last two ratios analyze debt by looking at the firm's income statement . The debt-to-total-assets ratio measures the percentage of funds provided by debt in order to fund total assets . Its equation is : (Total short term debt + Total long term debt) / Total assets High debt ratios that exceed the industry average may make it costly for a firm to borrow additional funds without first raising more equity . The times interest earned ratio measures the extent to which income can decline before the firm is unable to meet its annual interest expense payments . Its equation is EBIT / total interest payable : EBIT is used as the numerator because is paid with pretax dollars—the firm's ability to pay is not affected by taxes. The EBITDA coverage ratio is EBITDA / total interest : This ratio is more complete than the TIE ratio because it recognizes that depreciation and amortization are not expenses, so these amounts are available to service debt, and lease payments and principal repayments are fixed payments.

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