classes to go! company debt: a shot in the arm or a prescription for disaster? ann cuneaz

CLASSES TO GO!

Company Debt: A Shot in the Arm or a Prescription for Disaster?

Ann Cuneaz

BETTERINVESTING NATIONAL CONVENTION

Disclaimer• The information in this presentation is for educational purposes only and is not

intended to be a recommendation to purchase or sell any of the stocks, mutual funds, or other securities that may be referenced. The securities of companies referenced or featured in the seminar materials are for illustrative purposes only and are not to be considered endorsed or recommended for purchase or sale by BetterInvesting™ National Association of Investors Corporation (“BI”) or the BetterInvesting Volunteer Advisory Board, its volunteer advisory board (“BIVA”). The views expressed are those of the instructors, commentators, guests and participants, as the case may be, and do not necessarily represent those of BetterInvesting™ or BIVA. Investors should conduct their own review and analysis of any company of interest before making an investment decision.

• Securities discussed may be held by the instructors in their own personal portfolios or in those of their clients. BI presenters and volunteers are held to a strict code of conduct that precludes benefiting financially from educational presentations or public activities via any BetterInvesting programs, events and/or educational sessions in which they participate. Any violation is strictly prohibited and should be reported to the President of BetterInvesting or the Manager of Volunteer Relations.


WHAT IS DEBT?

• Money borrowed by one party from another

• Money that must be paid back at a later date, usually with interest

• Provides means to make large purchases not possible under normal circumstances


PERSONAL DEBT

• Mortgage

• Car loan

• Student loan

• Credit card debt


COMPANY DEBT

• New factories

• Expand to new location

• Computer systems

• Acquire a company


DEBT AS A SHOT IN THE ARM

• Financing new projects that have potential to increase revenues

• Refinancing debt at lower interest rate

• Rate of return is higher than the interest rate at which money is borrowed

• Kept at moderate level


OR PRESCRIPTION FOR DISASTER?

• Taking on more debt, when current debt level is substantial

• Unable to pay operating expenses without additional debt

• Repeatedly refinancing old debt

• Cost of debt is HIGHER than the rate of return


Provides financial

resources for

company growth

and expansion

.

Heavy burden in times

of economi

c recessio

n.


HIGHER DEBT HIGHER RISK


WHAT IS TOO MUCH?

• $9 Million?

• $90 Million?

• $9 Billion?

It depends!


CAPITALIZATION RATIO

• Long-term debt as % of capital structure

• Capital structure = LT debt + equity

Long-term Debt=

Long-term Debt + Shareholders’ Equity


CAPITALIZATION RATIO

• Low rate indicates “strong” balance sheet

• In general, less than 35% is desired– Varies by industry

• Reported on Stock Selection Guide

• Companies with high ratios said to be highly leveraged


INTEREST COVERAGE

• Indicates if company can afford the debt

• Measures how many times company earnings could pay interest expense

• Low ratio indicates debt expense may be a heavy burden.


INTEREST COVERAGE

• 10x means that earnings are 10 times larger than interest expense

• Coverage of 7x or 8x should be adequate for most companies

• Under 5 is a warning sign

• Under 3? Big REDRED flag

17


18*

Total interest coverage =

Pretax Profit + Tot. Interest Pd.

Tot. Interest Paid


INTEREST COVERAGE

19

If the economy slows and business falls off, which company is more likely to go

bankrupt because they can’t service their debt?

11.7x 1.9x


COMPANY LIQUIDITY

• Ability to pay day-to-day bills

• Indicates how prepared company is to pay bills that come due over the next year

• Measured by the Current Ratio


CURRENT RATIO

• Current assets: assets turned into cash within 1 year.– Cash, marketable securities, accounts

receivable, inventory

• Current liabilities: debt or obligations due within 1 year.– Account payable, current portion of long term

debt, accrued expenses (including taxes)

21


CURRENT RATIO

• Current Assets Current Liabilities• If current assets = $500,000, and current

liabilities = $250,000, current ratio is 2:1– For every $1 of current debt, there are $2 of

current assets to meet obligation

• In general, want 2:1, or higher– But consider industry averages

22


FINDING THE CURRENT RATIO


EVALUATING DEBT

• How much debt?– Capitalization ratio (less than 35%)

• Can company afford the debt?– Interest coverage (7 or more)

• Is company able to pay the bills?– Current ratio (2 or more)

• Guidelines may vary by industry


REFERENCES

• Using Portfolio Management Wisdom Handbook, Bonnie Biafore, BI Educational Series

• Financial Ratio Tutorial, www.investopedia.com/university/ratios/default.asp


Make A Difference In Someone’s Life

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Please pick up someBETTERINVESTING

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and introduce others to this opportunity.

classes to go! company debt: a shot in the arm or a prescription for disaster? ann cuneaz

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