Debt to Equity Ratio (D/E):
It calculates the load of total debt with respect to the shareholders equity. The formula of D/E ratio is shown below. D/E ratio highlights if a company is financial its total capital more out of debt or equity. A higher D/E ratio (>1) means the company’s capital structure is debt dependent. A lower D/E ratio (<1) means the company’s capital structure is relying more on equity.
D/E Ratio = Total Debt / Shareholders Equity
Interest Coverage Ratio (ICR):
ICR is a margin of safety which a company enjoys for paying the interest expenses. In other words, ICR is a representation of how easily a company can pay its interest expenses. How it is determined? It is done by dividing total interest due in a year by the company’s EBIT. The higher is the ICR the better.
ICR = EBIT / Interest Expense
Generally Accepted Accounting Principles (GAAP) is a collection of commonly-followed accounting rules and standards for financial reporting. GAAP’s format is used for reporting in company’s Balance Sheet, Profit & Loss Accounts, and cash flow statements. It is a standard which is followed by almost all companies across the world.
Working Capital (WC)
WC is that extra liquid cash which is available in the hands of company. This is free money which can remain idle in the company’s bank account after payment of all current liability.
Working Capital (WC) = CA – CL
- Current Asset (CA): Total liquid assets which can be converted into cash in next one year. Example of such assets is account receivables, raw material, work in progress, finished good inventory, pre-paid liability (advance), cash etc.
- Current Liability (CL): Total liability that must be paid in next one year. Example of such liability is account payables, interest dues, income tax dues, short term debts etc.
Current account is a bank account. Like we open savings account, companies open current account. Current account is used by companies to handle their day-to-day cash needs.
Like savings account, money can be withdrawn from current account at any time of the day using an ATM. Generally companies use either cheque or online payment mode to pay money from current account.
Banks do not pay any interest on deposits in current account. Apart from this all facilities of savings account is available for current account holder.
Why banks do not pay interest on current a/c? Because deposits in current account vary too much. Hence, bank’s are not able to deploy this money for onward use (like for loan issuance, short term investment etc).
Weighted Average Cost of Capital (WACC)
Company’s needs funds to run its operations. The sourced fund is called “capital”. A company can source funds in two ways: equity and debt. But to get these funds, the company must also compensated the borrower with a suitable returns.
For equity: Returns are in the form of dividend and price appreciation. For debt : return is in the form of interest payment. So for an company borrowing money dividend, price appreciation, interest payment is a “cost”.
WACC is the process of calculating this cost.
How to use WACC? Suppose that a company’s calculated WACC is say 8% per annum. In the past the return generated by this company is say 12% per annum. As WACC is less than return, it can be considered a profitable company. Check WACC calculation here.