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how to Measure the debt and equity of the company and identify the trends.
Also how to calculate the three current ratio to ascertain the short term liquidity and debt equity ratios to ascertain the leverage position.
ANSWER
1.how to Measure the debt and equity of the company and identify the trends.?
Capital structure describes the mix of a firm's long-term capital, which consists of a combination of debt and equity. Capital structure is a permanent type of funding that supports a company's growth and related assets.
Equity
The equity portion of the debt-equity relationship is easiest to define. In a capital structure, equity consists of a company's common and preferred stock plus retained earnings. This is considered invested capital and it appears in the shareholders' equity section of the balance sheet. Invested capital plus debt comprises capital structure.
Debt
A discussion of debt is less straightforward. Investment literature often equates a company's debt with its liabilities; however, there is an important distinction between operational liabilities and debt liabilities. It's the latter that forms the debt component of capital structure, though investment research analysts do not agree about what constitutes a debt liability.
ANALYSIS OF CAPITAL STRUCTURE
Many analysts define the debt component of capital structure as a balance sheet's long-term debt; however, this definition is too simplistic. Rather, the debt portion of a capital structure should consist of short-term borrowings (notes payable), long-term debt, and two-thirds (rule of thumb) of the principal amount of operating leases and redeemable preferred stock.
how to calculate the three current ratio to ascertain the short term liquidity and debt equity ratios to ascertain the leverage position ?
In general, analysts use three ratios to assess the strength of a company's capitalization structure. The first two are popular metrics: the debt ratio (total debt to total assets) and the debt-to-equity (D/E) ratio (total debt to total shareholders' equity). However, it is a third ratio, the capitalization ratio—(long-term debt divided by (long-term debt plus shareholders' equity))—that delivers key insights into a company's capital position.
With the debt ratio, more liabilities mean less equity and therefore indicate a more leveraged position. The problem with this measurement is that it is too broad in scope and gives equal weight to operational liabilities and debt liabilities.
The same criticism applies to the debt-to-equity ratio. Current and non-current operational liabilities, especially the latter, represent obligations that will be with the company forever. Also, unlike debt, there are no fixed payments of principal or interest attached to operational liabilities.
On the other hand, the capitalization ratio compares the debt component to the equity component of a company's capital structure; so, it presents a truer picture. Expressed as a percentage, a low number indicates a healthy equity cushion, which is always more desirable than a high percentage of the debt.
About Leverage
In finance, debt is a perfect example of the proverbial two-edged sword. Astute use of leverage (debt) is good. It increases the number of financial resources available to a company for growth and expansion.
With leverage, the assumption is that management can earn more on borrowed funds than what it would pay in interest expense and fees on these funds. However, to carry a large amount of debt successfully, a company must maintain a solid record of complying with its various borrowing commitments.
The Problem With Too Much Leverage
A company that is too highly leveraged (too much debt relative to equity) might find that eventually, its creditors restrict its freedom of action; or it could experience diminished profitability as a result of paying steep interest costs. In addition, a firm could have trouble meeting its operating and debt liabilities during periods of adverse economic conditions.
Or, if the business sector is extremely competitive, then competing companies could (and do) take advantage of debt-laden firms by swooping in to grab more market share. Of course, a worst-case scenario might be if a firm needed to declare bankruptcy.