Jaime is a Credit Officer of a Financial Institution. He has little time at the Institution where he works and is not fully convinced about the relevance of some financial ratios and their maximum limits for granting loans.
For example, a ratio that generates enormous doubt is that of equity debt, as a result of the ratio of Total Liabilities to Net Equity, whose reading is “the times that the company's equity is committed to its creditors”. For better illustration let's see the following case:
Total Liabilities (PT): S /. 10,000
Equity (P): S /. 10,000
Equity Debt (PT / P): 1 (or 100%)
Where it can be seen that "the assets of the company are 100% committed to its creditors."
In this regard, Jaime wonders:
- “ Why do you have to compare Total Liabilities with Equity? ”,“ Isn't Total Assets more relevant? ”.
- "It would not be better to compare Total Liabilities with Total Assets, which is what really matters in the event of collateral execution," he adds.
To answer Jaime's question, let's return to the previous case:
Total Assets (AT): S /. 20,000
Total Liabilities (PT): S /. 10,000
Equity (P): S /. 10,000
Asset Debt (PT / AT): 0.5 (or 50%)
Where it is seen that "the total assets of the company are 50% committed to creditors." Information, apparently more relevant, than the fact of saying: "the company's assets are 100% committed to its creditors." Especially since there is a margin of 50% of Total Assets financed with Equity, not committed with Creditors.
To delve further into the topic, let's take the following case:
Total Assets (AT): S /. 20,000
Total Liabilities (PT): S /. 15,000
Equity (P): S /. 5,000
Asset Debt (PT / AT): 0.75
Equity Debt (PT / P): 3 (or 300%)
Where it is appreciated, that although the patrimonial indebtedness is 3 times, the Total Assets is only 75% committed with creditors.
Therefore, the decision to grant loans, apparently, should be inclined more towards a maximum limit on Total Assets committed to Creditors (For example: 75%), than on a maximum limit on Equity committed to Creditors (For example: 300%). Very interesting and more realistic point of view, but taking into consideration the following:
- The composition of Assets (Current and Non-Current) and quality of Current Assets (trade receivables and inventories) and Non-Current Assets (market values).
- The existence or not, of liens, on the Total Assets.
And, most importantly, verifying the payment capacity of the company, through the calculation of coverage ratios (Net Cash Flow, among others) and the existence of liquidity necessary for the fulfillment of obligations (Cash Flow Statement).
