Corporate debt ratio
When making decisions, it is essential that the company takes into account the debt quality ratio. This tool allows you to know your maximum recommended level of indebtedness and so you can see whether the operation you want to carry out is viable or not.
What is debt quality and how can we measure it?
Debt quality is the proportion of a company’s debt that is due in the short term, compared to the proportion of corporate debt that is due in the long term. The longer the maturities, the better the debt quality. In order to measure this we use the ratio.
What is the debt quality ratio?
In order to know how to calculate the quality of debt we apply a ratio, but before applying the formula we must understand the data we are going to use in the formula:
Current liabilities: this is the total debt of the company that is due in the short term. In other words, with a maturity of less than one year.
- Non-current liabilities: all the company’s debt with long-term maturity.
- Total liabilities: the sum of current and non-current liabilities.
- Now that these concepts are clearer, we can go on to explain the debt quality ratio:
Quality of debt = (current liabilities / total liabilities) x 100
What is the acceptable level of debt
In order to calculate this ratio it is essential that the company’s accounts are up to date, and for this there is nothing better than to have the help of specialised software. This ensures that we really know what the quality of our company’s debt is.
After calculating the ratio, we know what proportion of the company’s total debt is represented by short-term debts, and we want to keep the proportion as small as possible.
A value of 0 indicates that all maturities are concentrated in the long term, which is almost impossible, while a value of 1 indicates that all maturities are in the short term. Therefore, what we are interested in is a result as close as possible to 0.
However, this should not be taken in absolute terms, since there are companies with debt ratios close to 1 that are perfectly capable of meeting short-term maturities without any problem.
Although knowing the quality of debt is essential, this is not the only factor to take into account when examining a company’s financial situation. Other factors such as the solvency ratio, which indicates the company’s ability to meet outstanding payments, must also be taken into account.
On the other hand, economic data must be brought into line with the reality of the business and the environment in which it operates.
What is clear is that the better we control our company’s finances, the easier it will be to access data at important moments and the easier it will be to make decisions. That is why knowing how to calculate the debt quality ratio is essential.