Current Asset is any asset which can reasonably be expected to be sold, consumed, or exhausted through the normal operations of a business within the current fiscal year or operating cycle (whichever period is longer).
CA includes cash, cash equivalents, short-term investments, accounts receivable, stock inventory and the portion of prepaid liabilities which will be paid within a year.
On a balance sheet, assets will typically be classified into current assets and long-term assets.
The current ratio is calculated by dividing total current assets by total current liabilities. It is frequently used as an indicator of a company's liquidity, its ability to meet short-term obligations.
Current Liabilities are often understood as all liabilities of the business that are to be settled in cash within the fiscal year or the operating cycle of a given firm, whichever period is longer.
A more complete definition is that current liabilities are obligations that will be settled by current assets or by the creation of new current liabilities.
An operating cycle for a firm is the average time that is required to go from cash to cash in producing revenues.
For example, accounts payable for goods, services or supplies that were purchased for use in the operation of the business and payable within a normal period would be current liabilities.
Bonds, mortgages and loans that are payable over a term exceeding one year would be fixed liabilities or long-term liabilities. However, the payments due on the long-term loans in the current fiscal year could be considered current liabilities if the amounts were material.
Amounts due to lenders/ bankers are never shown as accounts payable/ trade accounts payable, but will show up on the balance sheet of a company under the major heading of current liabilites, and often under the sub-heading of other current liabilites, instead of accounts payable, which are due to vendors.
Other current liabilites are due for payment according to the terms of the loan agreements, but when lender liabilites are shown as current vs. long term, they are due within the current fiscal year or earlier. Therefore, late payments from a previous fiscal year will carry over into the same position on the balance sheet as current liabilities which are not late in payment.
There may be footnotes in audited financial statements regarding past due payments to lenders, but this is not common practice. Lawsuits regarding loans payable are required to be shown on audited financial statements, but this is not necessarily common accounting practice.
The proper classification of liabilities provides useful information to investors and other users of the financial statements. It may be regarded as essential for allowing outsiders to consider a true picture of an organization's fiscal health.
One application is in the current ratio, defined as the firm's current assets divided by its current liabilities. A ratio higher than one means that current assets, if they can all be converted to cash, are more than sufficient to pay off current obligations. All other things equal, higher values of this ratio imply that a firm is more easily able to meet its obligations in the coming year.
In Bangladesh the issue of current liabilities are often seen as overlapping among different types of liabilities.
The standard C.A. /C.L ratio is 2:1
What is the 'Debt/Equity Ratio'
Debt/Equity Ratio is a debt ratio used to measure a company's financial leverage.
DE Ratio is calculated by dividing a company’s total liabilities by its stockholders' equity.
The D/E ratio indicates how much debt a company is using to finance its assets relative to the amount of value represented in shareholders’ equity.
The formula for calculating D/E ratios can be represented in the following way:
Debt - Equity Ratio = Total Liabilities / Shareholders' Equity
The result is expressed either as a number or as a percentage.
This form of D/E may often be referred to as risk or gearing.
This ratio can be applied to personal financial statements as well as corporate ones, in which case it is also known as the Personal Debt/Equity Ratio.
Here, “equity” refers not to the value of stakeholders’ shares but rather to the difference between the total value of a corporation or individual’s assets and that corporation or individual’s liabilities.
The formula for this form of the D/E ratio, then, can be represented as:
D/E = Total Liabilities / (Total Assets - Total Liabilities)
Some More Facts About DE Ratio --Debt/Equity Ratio'
Given that the debt/equity ratio measures a company’s debt relative to the total value of its stock, it is most often used to gauge the extent to which a company is taking on debts as a means of leveraging (attempting to increase its value by using borrowed money to fund various projects).
A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. Aggressive leveraging practices are often associated with high levels of risk. This may result in volatile earnings as a result of the additional interest expense.
For example, suppose a company has a total shareholder value of Rs.180,000 and has Rs.620,000 in liabilities. Its debt/equity ratio is then 3.4444 (620,000 / 180,000), or 344.44%, indicating that the company has been heavily taking on debt and thus has high risk.
Conversely, if it has a shareholder value of Rs620,000 and Rs.180,000 in liabilities, the company’s D/E ratio is 0.2903 (180,000 / 620,000), or 29.03%, indicating that the company has taken on relatively little debt and thus has low risk.
If a lot of debt is used to finance increased operations (high debt to equity), the company could potentially generate more earnings than it would have without this outside financing. If this were to increase earnings by a greater amount than the debt cost (interest), then the shareholders benefit as more earnings are being spread among the same amount of shareholders.
However, if the cost of this debt financing ends up outweighing the returns that the company generates on the debt through investment and business activities, stakeholders’ share values may take a hit.
If the cost of debt becomes too much for the company to handle, it can even lead to bankruptcy, which would leave shareholders with nothing.
The personal debt/equity ratio is often used in financing, as when an individual or corporation is applying for a loan.
This form of D/E essentially measures the Rupee amount of debt an individual or corporation has for each Rupee of equity they have.
D/E is very important to a lender when considering a candidate for a loan, as it can greatly contribute to the lender’s confidence (or lack thereof) in the candidate’s financial stability.
A candidate with a high personal debt/equity ratio has a high amount of debt relative to their available equity, and will not likely instill much confidence in the lender in the candidate’s ability to repay the loan.
On the other hand, a candidate with a low personal debt/equity ratio has relatively low debt, and thus poses much less risk to the lender should the lender agree to provide the loan, as the candidate would appear to have a reasonable ability to repay the loan.
Limitations of 'Debt/Equity Ratio'
Like with most ratios, when using the debt/equity ratio it is very important to consider the industry in which the company operates.
Because different industries rely on different amounts of capital to operate and use that capital in different ways, a relatively high D/E ratio may be common in one industry while a relatively low D/E may be common in another.
For example, capital-intensive industries such as auto manufacturing tend to have a debt/equity ratio above 2, while companies like personal computer manufacturers usually are not particularly capital intensive and may often have a debt/equity ratio of under 0.5.
As such, D/E ratios should only be used to compare companies when those companies operate within the same industry.
Another important point to consider when assessing D/E ratios is that the “Total Liabilities” portion of the formula may often be determined in a variety of ways by different companies, some of which are not actually the sum of all of the company’s liabilities. In some cases, companies will only incorporate debts (like loans and debt securities) into the liabilities portion of the formula, while omitting other kinds of liabilities (unearned revenue, etc.).
In other cases, companies may calculate D/E in an even more specific way, including only long-term debts and excluding short-term debts and other liabilities. Yet, “long-term debt” here is not necessarily a term with a consistent meaning. It may include all long-term debts, but it may also exclude long-term debts nearing maturity, which are then categorized as “short-term” debts.
Because of these differentiations, when considering a company’s D/E ratio one should try to determine how the ratio was calculated and should be sure to consider other ratios and performance metrics as well
The debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of shareholders' equity and debt used to finance a company's assets.
Closely related to leveraging, the ratio is also known as Risk, Gearing or Leverage.
The two components are often taken from the firm's balance sheet or statement of financial position (so-called book value), but the ratio may also be calculated using market values for both, if the company's debt and equity are publicly traded, or using a combination of book value for debt and market value for equity financially.
Debt to Equity Ratio
The debt to equity ratio measures the riskiness of a company's financial structure. The ratio reveals the relative proportions of debt and equity financing that a business employs. It is closely monitored by lenders and creditors, since it can provide early warning that an organization is so overwhelmed by debt that it is unable to meet its payment obligations. This is also a funding issue. For example, the owners of a business may not want to contribute any more cash to the company, so they acquire more debt to address the cash shortfall. Or, a company may use debt to buy back shares, thereby increasing the return on investment to the remaining shareholders.
Whatever the reason for debt usage, the outcome can be catastrophic, if corporate cash flows are not sufficient to make ongoing debt payments. This is a concern to lenders, whose loans may not be paid back. Suppliers are concerned about the ratio for the same reason. A lender can protect its interests by imposing collateral requirements or restrictive covenants; suppliers usually offer credit with less restrictive terms, and so can suffer more if a company is unable to meet its payment obligations to them.
How to Calculate the Debt to Equity Ratio
To calculate the debt to equity ratio, simply divide total debt by total equity. In this calculation, the debt figure should include the residual obligation amount of all leases. The formula is:
Long-term debt + Short-term debt + Leases
Equity
Equity
Example of the Debt to Equity Ratio
For example, New Centurion Corporation has accumulated a significant amount of debt while acquiring several competing providers of Latin text translations. New Centurion's existing debt covenants stipulate that it cannot go beyond a debt to equity ratio of 2:1. Its latest planned acquisition will cost $10 million. New Centurion's current level of equity is $50 million, and its current level of debt is $91 million. Given this information, the proposed acquisition will result in the following debt to equity ratio:
$91 Million existing debt + $10 Million proposed debt
$50 Million equity
$50 Million equity
= 2.02:1 debt to equity ratio
The ratio exceeds the existing covenant, so New Centurion cannot use this form of financing to complete the proposed acquisition.
Issues with the Debt to Equity Ratio
Though quite useful, the ratio can be misleading in some situations. For example, if the equity of a business includes a large proportion of preferred stock, a significant dividend may be mandated under the terms of the stock agreement, which impacts the amount of residual cash flow available to pay debt. In this case, the preferred stock has characteristics of debt, rather than equity.
Another issue is that the ratio by itself does not state the imminence of debt repayment. It could be in the near future, or so far off that it is not a consideration. In the latter case, a high debt to equity ratio may be less of a concern.
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