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Debt Ratio Analysis

See Also:
Financial Ratios
Debt to Equity Ratio
Current Ratio
Time Interest Earned Ratio Analysis
Debt Service Coverage Ration (DSCR)

Debt Ratio Definition

Debt ratio, defined as an expression of the relationship between a company’s total debt and assets, is a measure of the ability to service the debt of a company. It indicates what proportion of a company’s financing asset is from debt, making it a good way to check a company’s long-term solvency. In general, a lower ratio is better. Value of 1 or less in debt ratios shows good financial health of a company.

Debt Ratio Meaning

Debt ratio, meaning a measure of the financial stability of a company, is a common evaluation for any investment which requires a loan. The lower the company’s reliance on debt for asset formation, the less risky the company is. On the other hand, the higher ratio means a company has high insolvent risk since excessive debt can lead to a heavy debt repayment burden.

Debt Ratio Formula

The debt ratio formula is used more simply than one would expect:

Debt ratio = total debt / total assets

Debt Ratio Calculation

A simple debt ratio calculation will put the simplicity of this equation into perspective.

Example: a company has $10,000 in total assets, and $8,000 in total debts. Debt ratio = 8,000 / 10,000 = 0.8

This means that a company has $0.8 in debt for every dollar of assets and is in a good financial health.

Debt Ratio Example

Riley is the average accountant. Showing up to the office from 9 – 5 every day Riley has earned her living through hours of study, analysis, and application. To Riley, the principals of accounting are useful for both professional and personal uses.

Riley is very good at equations such as debt ratio, mortgages and multinational corporations the same. Today, she wants to apply what she knows to her home financing. The debt ratio analysis she performs is listed below:

Riley has $10,000 in home equity and $100,000 in total debts.

Debt ratio = $100,000 / $10,000 = 10

This means that Riley has $10 in debt for every dollar of home equity.

Riley knows a web based debt ratio calculator will not serve the purpose that a skilled and certified analyst can. Riley is one of these people. She values her skills as she moves forward in her life.

Resources

For statistical information about industry financial ratios, please click the following website: www.bizstats.com and www.valueline.com.

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Due Diligence

See Also:
Due Diligence on Lenders
Auditor
Mergers and Acquisitions (M&A)
Audit Committee
Loan Agreement

Due Diligence Definition

Due Diligence is an extensive qualitative and quantitative look at a company in order to make the best informed business decision about a company. Due Diligence is often associated with audits, where it is required before a public offering, as well as mergers and acquisitions in order to reduce the risk in the market for these activities.

Due Diligence Meaning

Due Diligence often becomes necessary when a large transaction is about to take place like a merger or loan agreement, or when the company’s financials are going to be presented to the public. Often times due diligence requires that an assessment be made qualitatively as well as quantitatively. A qualitative act of due diligence may be to assess the mental state and capability of the management. This can be done through plant tours to see how the company is run, down to interviews with several employees, suppliers, buyers and others who deal with the company on a day to day basis. Quantitative due diligence includes thorough investigations of the books and records. This can range from asset appraisals to day to day transactions. A thorough understanding of internal controls and its effectiveness also become necessary to ensure the risk for the business is as low as possible.

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Down Payment Definition

See Also:
Payment Terms
Notes Payable
Payroll Accounting
PEO Arrangement Compared to Outsourcing Payroll
Payback Period Method

Down Payment Definition

A down payment can be defined as an initial payment towards the financing of an expensive purchase. For individuals, this purchase is similar to a car or home. For businesses, however, this purchase could be a number of things: land, a warehouse, machinery, servers, or almost anything. Down payments are a deposit which assures to the financier that you will pay your debt. The down payment is usually larger than subsequent principal payments.

Down Payment Explanation

A down payment can be explained as a partial payment towards a purchase. They are made towards either trade credit or the financier of a purchase. It is decided on by the financier and accepted by the purchaser. A down payment is a percentage of the value of the loan.

Down payments are, in some senses, a goodwill measure. They ensure the financial stability and willingness to participate on the part of the purchaser. Though it may not seem like this, the down payment serves this purpose and is thus a staple concept when products are financed. The rationale is simple: if the purchaser is willing to pay the down payment the party is at least responsible enough to do so. The down payment mitigates some of the risk the financier takes when making an agreement with the customer.

Be weary of the no down payment business loans available on the internet. It is up to you to make sure you read all contracts fully. Financing a business is a difficult process, if someone is offering a deal that is too good to be true, chances are that it is not true at all.

Down Payment Example

Joey is going to purchase another 18 wheeler for his distribution business. He needs this tool to continue operations. Though Joey can not pay for the truck fully he can afford to finance it.

Joey has aligned a financier to help him cover the cost of the truck. The financier requires regular principal and interest payments to assure that the truck will be paid off. Additionally, the financier requires a down payment. The down payment, a somewhat substantial sum, establishes that Joey is willing to work with the party he is borrowing from.

Six months later, Joey completely pays off the truck. He does this simply and moves on to making more profits. By satisfying the needs of the lender Joey can move on to bigger and better things. Soon he will make a down payment on land in order to build a new distribution warehouse.

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Double-Declining Method Depreciation

See Also:
Double-Declining Depreciation Formula
accelerated method of depreciation
Double-Declining Method Depreciation
Straight-Line Depreciation
Depreciation
GAAP
Fixed Assets – NonCurrent Assets

Double Declining Depreciation: Definition

Double-declining depreciation, defined as an accelerated method of depreciation, is a GAAP approved method for discounting the value of equipment as it ages. It depreciates a tangible asset using twice the straight-line depreciation rate.

Double Declining Depreciation: Explanation

Double declining depreciation, explained as one of the most common methods to depreciate tools, is everywhere. The idea is that the asset’s value declines more steeply in the early years of usage. The result is that the depreciation expenses are larger in beginning and get smaller over time.

Companies often use this method of depreciation for tax purposes. Because the depreciation expenses are larger in the early periods of the asset’s useful life, the tax savings are greater in the beginning of the depreciation cycle and the tax benefits come sooner.

Double-Declining Balance Method: Schedule

When using double-declining balance method schedule, the depreciation rate stays the same, the depreciation expense gets smaller each period, and the depreciable base gets smaller each period.

Begin with the depreciable base, and calculate the depreciation expense for the period. Subtract that depreciation expense from the depreciable base to get the depreciable base for the next period. Repeat this process until you reach the salvage value. If the final depreciation expense would bring the asset value below salvage value, then simply subtract salvage value from that period’s depreciable base to get the final depreciation expense.

For example, if you have an asset with a purchase price of $1,000, a salvage value of $100, and a useful life of 5 years, then the straight-line depreciation rate will be 20%. The double-declining depreciation rate would then be 40%. The double declining depreciation table for the asset would look like this:

YearDepreciable Base      Depreciation Rate      Depreciation Expense

  1    $1,000                  40%                               $400
  2    $600                    40%                               $240
  3    $360                    40%                               $144
  4    $216                    40%                               $86.40
  5    $129.60                  -                                $29.60

 

Double Declining Depreciation: Example

Brian is an accountant for small businesses. Brian, a trained CPA, uses his skills to make sure each of his client businesses receives the financial management it needs.

Brian is approached by a customer who needs to depreciate his equipment. Brian naturally turns to double declining depreciation; gaap compliance, simple application, and other benefits of this method make it a perfect fit for this job. Brian collects information and performs the calculation below:

Purchase price is $1,000; Salvage value is $100; and useful life is 5 years

Depreciable Base = $1,000 – $100 = $900

Depreciation Expense = $900 / 5 = 180

Double Declining Depreciation Rate = $180 / $900 = 20%

Brian finds that the double declining depreciation method, here, yields a rate of 20%. He then creates the schedule above. This allows a clear understanding of how each depreciation expense relates to time.

Brian knows the value of financial management. Where many potential clients have failed, he has led many of his customers to success through this alone. He values the double declining depreciation schedule he has created here because it may create the same effect for this client.

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Debits and Credits

See Also:
Accounting Asset Definition
Accounting For Factored Receivables
Accounting Fraud Prevention using QuickBooks
Accounting Income vs. Economic Income
Financial Accounting Standards Board (FASB)
Imprest Account

Debits and Credits Definition

Debits and credits, defined as the double recorded method which is the centerpiece of accounting, are used by accountants across the world. The benefit to using debits and credits, is that they provide double redundant record keeping for expenditures; money is both added and subtracted. This creates 2 places for expenses on financial records, preventing issues from improper recording.

Debits and Credits Explanation

Debits and credits, explained as the error-proof method for accounting, allow accountants to have twice the records. Debits and credits basics exist as such: there is a debit and credit account for each of the journal entries. Debit accounts is where money is taken from the company. Credit accounts, on the other hand, is where money is added to a business.

Debits and Credits: History

Debits and credits accounts were formally invented in the 15th century by Luca Pacioli, as an official system to specify what was already used by merchants in Venice. These formal roots trace as far back as the Roman empire, there a side for a creditor and a side for a debtor existed. They were used in the Middle East, Florence, the Mediici bank, and finally found a home in Venice.

Debits and Credits: Rules

In either of these, a debit or credit can occur. If a debit occurs in a debit account, money is taken from the company. If a debit occurs in a credit account, money is taken from a company to be later added to another company credit account. To make the double entry work with this contra accounts were created: accounts which exist merely to balance the effect happening in another account. This is how debits and credits double entrycan occur. It may seem confusing to the average person, but accountants love that this method is redundant. It lends to pristine recording which can be checked in multiple places.

Debits and Credits in Bookkeeping

The double entry bookkeeping method is used by any respectable accountant. Debits and credits in quickbooks, for example, allow the system to make sense to the accountant as well as the untrained record-keeper. This method, through software like this, has been made useful for everyone.

Debits and Credits Example

Steven is a part time bookkeeper for a small boutique in a strip mall near his house. He shows up to keep records for the company owners, who are too busy with the operations of their business. Quickbooks is Steven’s best friend when he is in the office.

Steven never understood how debits and credits work. Then, one day, the company accountant visited the office. He was able to pick her brain. The experience was quite enlightening.

The accountant told Steven about how double entry bookkeeping works. By showing t accounts debits and credits examples he finally understood. This eventually proved useful.

One day Steven overheard the owners express how their financial records had an error. After listening, he was able to look at the records. He took his knowledge of accounting, recently learned, to move an unnamed expense in the software. This corrected the problem and Steven was even given a bonus.

Understanding debits and credits in accounting has greatly helped Steven. After his experiences he has decided to become an accountant. He will work closely with these records for the rest of his life.

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Double-Declining Depreciation Formula

See Also:
Double-Declining Method Depreciation

Double Declining Method Formula

To implement the double declining Depreciation equation for an Asset you need to know the asset’s purchase price, salvage value, and useful life. The salvage value is the amount the asset is worth at the end of its useful life. The depreciable base is the purchase price minus the salvage value. Depreciation continues until the asset value declines to its salvage value.

First, calculate the depreciable base and the depreciation expense. Next, calculate the straight-line depreciation rate. Then multiply the straight-line depreciation rate by two. Once you have the double-declining depreciation rate, you must create a depreciation schedule, as shown below.

Depreciable Base = Purchase Price – Salvage Value

Depreciation Expense = Depreciable Base / Useful Life

Straight-line Depreciation Rate = Depreciation Expense / Depreciable Base

Double-declining Depreciation Rate = Straight-line Depreciation Rate x 2

Double Declining Method Calculation Example:

Fedcorp Industries made a purchase of a delivery van to transport merchandise. The van purchase price is $1,000. Fedcorp also determines that the van’s salvage value is $100. Finally, the company figures that the van will retain a useful life of 5 years. Using the information that the company has determined, how would Fedcorp Industries determine the double-declining depreciation rate on the delivery van?

As shown above, the depreciable base must be calculated to start. This is done by taking the salvage value ($100) and subtracting that from the purchase price ($1,000) to get the depreciable base. Once that value is calculated, the depreciation expense must be found by dividing the depreciable base of the van ($900) by the estimated useful life of the van (5 years). Furthermore, in order to calculate the double-declining depreciation method, the straight-line method must be determined first. To do this, the depreciation expense must be divided by the depreciable base that was determined in the first place. This is done by taking the $180 of depreciation expense and dividing that total by the $900 of depreciable base for the van that was determined in the beginning. Once the straight-line rate has been calculated, one needs only double this final figure in order to determine the double-declining depreciation method. Multiply the 20% by 2 and the depreciation rate has been determined. The solution has been worked out below:

Depreciable Base = $1,000 – $100 = $900

Depreciation Expense = $900 / 5 = 180

Straight-Line Depreciation Rate= $180 / $900 = 20%

Double-Declining Depreciation Method = 20%*2 = 40%

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Debit Memorandum (memo)

See Also:
Credit Memorandum (memo)
Account Reconciliation
Credit Sales
Chart of Accounts (COA)
Accounting Principles

Debit Memo Definition

A debit memorandum or memo is a form or document, sometimes called a debit memo invoice, that informs a buyer that the seller is debiting or increasing its amount in the accounts receivable, thus increasing the amount of the buyer’s accounts payable due to extenuating circumstances.

Debit Memo Meaning

A debit memo is often issued when a seller has not billed or charged enough to the buyer, or it might come from another error or any other factor requiring an adjustment. When a seller issues a debit memo, it is normally required that the seller give specific details why the current memo is being issued. A debit memo pertaining to banks, called a debit memo bank statement, informs a depositor that the bank will be decreasing that particular account from something other than a debit or check payment. This is usually a bank service charge of some sort.

Debit Memo Example

Cindy works for Fluffy Stuffs Inc., a toy company specializing in the manufacture of stuffed animals. The company has recently sold a large shipment of stuffed animals to Toys N’ More. Cindy billed the company for the stuffed animals sold, but worked off of an old pricing sheet to create the invoice. This is normally not a large problem except that the market price for stuffing has increased dramatically. Therefore, Cindy has created a debit memo to inform Toys N’ More of the increase in price due to current market conditions.

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