Debt Utilization Ratios

The debt utilization ratios measure the proportion of debt and how efficiently management used the debt capital. The higher the ratio, the greater the amount other peoples money being used in an attempt to generate profits. There are some ratios under these criteria. They are as follows:

1. Debt Ratio
2. Time interest earned

Debt Ratio

The debt ratio measures the proportion of total assets financed by the time’s creditor. The higher the ratio, the greater the amount other peoples money being used in an attempt to generate profits. The ratio is calculated as follows:

Debt Ratio =Total liabilities / Total assets

Ratio                   2001             2000           1999            1998               1997
Debt Ratio         33.86%          41.03%      41.62%        43.59%          35.49%

Analysis
Analysis shows that debt ratio has continuously decreased from 1998 though the total liability has decreased only in the year 2001. The ratio has decreased because total asset had increased at a higher rate than total debt. And it’s a good sign for the company. In this case creditor will allow them to sell their product to them on credit. The company is following the policy to pay the debt immediately. Thus the way they can save interest expanse. And as a result their net income will be high within a short period of time.

Time interest earned

A useful measure of profit that does not link return to resources is the times interest earned ratio. It shows whether the company is able to pay it’s annual interest cost. Failure to meet this obligation can bring legal action by they firm’s creditors, possibly resulting in bankruptcy. It is calculated by dividing the firms operating income by the interest that it must pay on it’s debt.

Time interest earned = EBIT / Interest charged

Ratio                                  2001              2000              1999             1998               1997     
Time interest earned     6.52 Times      9.57 Times     6.38 Times     7.00 Times      5.74 Times

Analysis

Higher ratio of time interest earned means firm has higher ability to pay the interest from their opportunity income. In this analysis we see that there is a mass movement of this ratio over 5 years. There is a sharp decline of this ratio in 2001 from 2000 indicated that the firm is paying more interest. In this year EBIT has increased only 6.75% but interest has increased about 56.12%.
By analyzing this ratio we must say that the company must decrease their short-term Bank loan and if they continue to take loan this way, they will fall in big problem and it might be cause of bankruptcy.