One of the important indicators that you must check when investing in a company is'Debt Ratio'. We will discuss this in detail.

Understanding the Debt Ratio, an Essential Indicator for Corporate Investment

Debt ratio is one of the most important indicators for evaluating a company's financial health. It is the ratio of a company's total debt to its equity. In other words, this indicator shows how much debt a company has relative to its own capital.

This is mainly used by financial institutions and investors to evaluate a company's debt repayment ability and creditworthiness. Generally, if the debt ratio is less than 100%, it is considered that the company's financial status is sound, while if it is over 200%, it is considered risky.

For example, if Company A has equity of 100 million won and total debt of 200 million won, its debt ratio is 200%. On the other hand, if Company B has equity of 300 million won and total debt of 150 million won, its debt ratio is 50%. In this case, it can be concluded that Company B has a relatively stable financial status.

Investors need to analyze various financial indicators, including the debt ratio, to understand the company's business performance and future growth potential, and make appropriate investment decisions.

Why the Debt Ratio is Important and its Value in Company Analysis

The debt ratio is one of the key indicators that show a company's overall financial condition. There are several reasons why this is important.

• The debt ratio shows a company's debt repayment ability. Companies with high debt ratios are more likely to have difficulty paying interest and principal. This can lead to bankruptcy or other financial crises, posing a risk to investors.
• It allows you to understand a company's financing method and the associated interest costs. Companies that use a lot of debt tend to have higher interest costs, which can affect profitability. Investors need to consider this when making investment decisions.
• It helps predict a company's growth potential and sustainability. Companies with low debt ratios can pursue active investment and growth based on a stable financial structure, while companies with high debt ratios may be limited in their growth due to excessive debt burden.

Debt Ratio Calculation Method and Real Case Analysis

Debt Ratio is a ratio of a company's total debt to its equity, and is one of the most important indicators for evaluating the health of a company's financial structure. The formula is as follows:

• Debt Ratio = (Total Debt / Equity) x 100%

For example, if Company A has total debt of 100 billion won and equity of 50 billion won, its debt ratio is 200%.

Let's calculate the debt ratio of Samsung Electronics based on its financial statements for the third quarter of 2022. As of the end of the quarter, Samsung Electronics' total debt was approximately 309 trillion won and its equity was approximately 352 trillion won.

Therefore, by substituting it into the above formula, we can see that Samsung Electronics' debt ratio is 87.8%. It can be confirmed that Samsung Electronics is maintaining a debt ratio lower than the industry average, which means that its financial health is relatively high.

Based on this calculated debt ratio, it can be used to judge the company's financial situation and refer to investment decisions.

Stable Range of Debt Ratio and Differences by Industry

Generally, a debt ratio of less than 100% is considered good, and over 200% is considered risky. However, this is not an absolute standard, and the appropriate level of debt ratio may vary depending on the industry.

In the manufacturing industry, large-scale financing is required for facility investment, so the debt ratio tends to be relatively high. The financial industry, on the other hand, operates based on customer deposits, so the debt ratio is low. Even within the manufacturing industry, shipbuilding industries, which have long shipbuilding periods, may have high debt ratios.

Recently, there is a trend to comprehensively evaluate the financial health of companies using various financial indicators such as debt dependency and interest coverage ratio, in addition to the debt ratio. Debt dependency is an indicator of the proportion of debt in total assets, and a level of 30% or less is considered appropriate. The interest coverage ratio is the value obtained by dividing operating profit by interest expense, and a value of 1 or more indicates that operating profit can cover interest expense.

Impact of High Debt Ratio on Companies

A high debt ratio means that a company relies more on debt (other people's capital) than its own capital. This can have the following negative impacts.

• Deterioration of profitability due to increased interest costs. Interest on debt is one of a company's fixed costs, and the higher the debt ratio, the more interest costs increase. This can reduce a company's net income, leading to lower profitability.
• Liquidity risk due to increased repayment pressure. The higher the debt ratio, the more creditors may increase repayment pressure, which can worsen a company's liquidity. If a company fails to secure sufficient liquidity, it may face a default situation.
• Difficulty in financing due to lower credit rating. A high debt ratio is one of the factors that can lower a company's credit rating. If the credit rating goes down, the company's financing costs will increase, and financing itself may become difficult.
• Threat to management control. If creditors sell shares they have taken as collateral to increase repayment pressure, management control can be threatened.

Strategies for Utilizing the Debt Ratio When Making Investment Decisions

The debt ratio is an important indicator of a company's financial condition, and can be actively used when making investment decisions. Here are some strategies that utilize the debt ratio.

• Choose companies with low debt ratios for safe investments. Companies with debt ratios generally below 100% are considered relatively safe. However, the criteria may vary depending on the industry or company characteristics, so it is a good idea to compare them to the average debt ratio of the relevant industry.
• Analyze companies with high debt ratios to find companies with high growth potential. Even if the debt ratio is high, if the company has high growth potential, it can be decided to invest by accepting this.At this time, you must also consider the company's interest coverage ratio (operating profit / interest expense). If the interest coverage ratio is less than 1, it means that the company cannot even cover interest expenses with operating profits..
• Understand the trend of the debt ratio. Even if the debt ratio has increased temporarily, if the trend is improving, the outlook may be positive in the future. Conversely, if the debt ratio is steadily increasing, it means that the company's financial condition is deteriorating, so caution is needed.

Conclusion

As you can see, the financial statements contain a lot of information that we may not know. So, if you are worried about stock investment or business planning, please take a look.