Metrics to Help You Manage Debt, Assets, and Investments¹
There are many metrics available to assist businesses and their investors with measuring how well they are utilizing their assets, debt and investments. Below are five useful metrics that can be used to compare how the company is tracking from period to period as well as against industry standards.
Debt to Equity Ratio
This ratio helps a company determine, based on its equity, if the company has borrowed too heavily or if it is able to fund its operations using its own cash flow. A higher Debt to Equity Ratio indicates to investors and to other outsiders that the company is borrowing too heavily and that may cause some uneasiness. The formula for the Debt to Equity ratio is:
Total Liabilities / Total Stockholders Equity = Debt to Equity Ratio
As an example, the XYZ Company's total liabilities on its Balance Sheet, for 2017, were $200,000. It's total Stockholders' Equity was $300,000. By using the formula we can find its Debt to Equity Ratio:
$200,000 / $300,000 = .67
Let's say that for the year 2016, the company's Debt to Equity Ratio was .75. This means that the company has improved its Debt to Equity position by using less debt and funding operations on its own.
The Debt to Equity is a ratio that a lot of lenders pay close attention to as it helps them gauge if the company might have a problem with paying back their loan.
Return on Investment
This metric is a very popular and highly used metric because of its simplicity. This metric allows you to find out how much an investment will return in the form of revenue or profit for the company. This can help companies make decisions on what type of large purchases or investments they should make. The formula for Return on Investment is:
(Return - Cost of Investment) / Cost of Investment = Return on Investment
Let's say that the XYZ Company wants to purchase a new machine for its factory. They estimate that with the new machine it will bring in an additional $300,000 in sales over the next 5 years, the life of the machine. The machine cost $50,000. Using our formula the company can determine their estimated Return on Investment.
($300,000 - $50,000) / $50,000 = 5
This means that the XYZ will get a 5 times return on their investment. The higher the Return on Investment ratio, the higher the investment will yield. This is especially useful when comparing multiple options as you will be able to decide which option will yield the most return.
Asset Turnover Ratio
This metric allows a company to calculate how much sales are generated using its assets. This is especially useful when comparing this metric to other companies in the same industry. This can help investors and management determine if they are procuring the right assets and if they are using their assets efficiently. The formula for the Asset Turnover Ratio is:
Total Revenue / Total Assets = Asset Turnover Ratio
Let's say the XYZ Company, for the year 2014, has $500,000 in Revenue and had $400,000 in Assets. They can use this formula to see how efficient they are at using their assets to create revenue.
($500,000) / ($400,000) = 1.25
This means that their assets "turned over" 1.25. In other words, $1.25 in sales were generated with every $1.00 in assets. The goal should be to increase this ratio so that a company is becoming more efficient at using its assets.
Return on Assets
This metric is very similar to the Asset Turnover Ratio. A company can use the Return on Assets ratio to calculate the return for every dollar it spent on assets. This metric allows investors to know how well their investment is being paid off. The idea is that their investment purchased the assets and they want to know how much return their assets are yielding. The formula for Return on Assets is:
Net Income / Total Assets = Return on Assets
As an example, the XYZ Company's Net Income, for 2014, was $400,000. It's total assets were $300,000. Using the formula we can determine the Return on Assets ratio:
($400,000) / ($300,000) = 1.33
That means the company has earned $1.33 for every $1 in assets. An investor can compare this metric across their portfolio and across companies in the same industry to see how well their investment is being used.
Return on Equity
This is a very similar metric to the Return on Assets ratio. In this metric, we are comparing income with stockholders equity. This can be used to determine how efficient the company is at generating income from its investment. This metric is also useful when comparing it to other companies in the same industry. The formula for the Return on Equity is:
Net Income / Avg. Stockholders Equity = Return on Equity
As an example, the XYZ Company's Net Income, for 2017, was $400,000. Its average Stockholder's Equity was $1,000,000. Using the formula we can determine its Return on Equity:
$400,000 / $1,000,000 = .4
The higher the value, the more efficient the company is at generating income using investments in the company. The XYZ Company's Return on Equity is at .4 for the year 2017. If the same company's Return on Equity was .3 for the year 2016 then the company was able to become more efficient at generating income using the money that was invested by the stockholders.