Hi All,
i’ve read in many places that DE is suppose to be calculated on LT debt.
However its difficult (read “i dont know”) to figure out what portion of the short term debt may get added to LT debt in the coming years.
Around this a couple of questions
1.) when a company reports Short Term debt , is it absolutely imperative that the debt be cleared in the CY only?
2.) If i remove the Short Term Debt from Debt/equity ratio, will it not give a higher leverage for the calculation which could be wrong, because from what i believe any debt is debt, and even if it is short term debt it needs to be accounted .
What am i missing in understanding?
3 Likes
For your questions:
- Yes, if company is unable to refinance the same to be a Long-term debt.
- Yes
Here are my thoughts:
Focusing on the short-term debt is extremely important due to the fact that sooner or later any long-term debt would become short-term as well as the bankruptcy process is triggered from the inability to pay short term debt.
Monitoring of short-term debt is extremely important for a business that can NOT convert the current assets (Cash, Accounts Receivable and Inventory) in to hard cash in order to meet short-term liabilities. Let’s explore deeper in to the major components of current assets:
1- Cash: May not be as liquid as you may think. Just imagine situations where cash is earned and kept in a foreign jurisdictions or cash in hand is needed to fund working capital.
2- Accounts Receivable: How long it takes to convert Accounts Receivable to cash? Calculate receivables turnover (in days) = (Net sales/accounts receivable) *365 Inventory:
3- Inventory: How long it takes to convert inventory to cash? Calculate Inventory turnover (in days) = (Cost of goods sold/inventory) *365
Besides short and long term debts that you already mentioned in your note, do consider the Off-Balance Sheet debts, which is equally lethal but mentioned in the footnotes instead of the balance sheet. These are contractual obligations (such as Lease obligations, Warranties, Purchase contracts, and Unfunded pension liabilities).
In the nutshell, avoid considering the short-term debt in case business is strong enough to liquidate the current assets to meet short-term liabilities.
Trust that helps.
2 Likes
Hmm…
This is an interesting opinion.
Thanks for clarifying my doubt. So its always to safe to take the DE ratio from a case by case basis.
thanks again.
