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Long Term Debt to Total Asset Example

Long Term Debt To Total Asset Ratio Example

Wiles is the CFO of a major corporation, Blastcorp. Blastcorp has been an extremely successful company, with expectations that it will become more successful and larger over time. In addition to the success and growth of the company, Wiles has managed his company properly up to this point, taking over and expanding operations to levels he had only hoped for. Wiles is now performing his monthly due diligence.

Wiles wants to know the ratio for Long Term Debt to Total Assets for his company. It is important to note that the long term debt to total asset ratio needs to be as low as possible. This makes sense because as the long term debt lowers or the total assets rises, the ratio goes down. Because both of those situations mean that the company is doing positive business. It seems obvious that lowering the long term debt to the total asset ratio is important for a company’s success. In order to calculate the ratio, he needs to be aware of the total long term debt that is associated with his company, as well as the figure for his total number of assets that is likewise associated with his company. This provides him information on solvency, the ability to meet financial covenants (requirements) for his loan provider, and a general measure of the performance of the corporation Wiles works for. He reviews his financial statements to find the information below. Wiles then performs a long term debt to total asset ratio calculation. The calculation is performed below:

Calculations

$10,000,000 in total assets and $5,000,000 in long term debt

Long debt to total asset ratio = $5,000,000 / $10,000,000 = 0.5

This means that a company has $0.5 in long term debt for every dollar of assets.

Wiles must now review his loan agreement to assure himself that the corporation he works for will not violate covenants made for the coming months of this year. He finds that his company is safe.

Wiles would like to lower this Long Term Debt to Total Asset ratio. He makes a goal of making it only .4 or 40%. Due to the fact that Wiles is keeping up-to-date with his information and goal setting he can create the path to achieving his benchmark.

Long Term Debt to Total Asset

See Also:
Long Term Debt to Total Asset Ratio Analysis
Debt Ratio Analysis
Net Profit Margin Ratio
Company Debt: Pay Down or Borrow?

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The Dreaded “F” Word

See Also:
What is Factoring Receivables
Accounting for Factored Receivables
Journal Entries for Factored Receivables
Can Factoring Be Better Than a Bank Loan?
History of Factoring
How Factoring Can Make or Save Money
Factoring is Not for My Company
The What, When, and Where About Factoring
Working Capital

Factoring: The Dreaded “F” Word

The dreaded “F” word, FACTORING. Now that factoring has been said, I am sure we all are feeling a little more at ease. I was in a meeting recently with a prospect, a Houston based oilfield servicing company, and their CPA whose name was John.

The company was experiencing cash flow problems because of growth. And they have more new business opportunities coming up in the near future. They were trying to determine how to capitalize on these opportunities in their situation of stressed cash flow. The topic of factoring their accounts receivable came up and John said “Only companies about to go broke factor their accounts receivable!” Knowing the CPA profession as I do since I was a CPA earlier in my career, I knew John’s concern was cost. So I had to ask him why he felt that way. He did not disappoint me when he said “factoring is too expensive.” I then told him that I would not normally recommend factoring to any client unless it will make or save them money.


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Situations Where Factoring Would Make or Save Money

John then asked me “Tell us some situations where factoring would make or save money.” Knowing that he thought he had me now, I gave him the following examples:

Conclusion

Taken back a bit John still held his ground by saying “It is still to expensive and it will break a company!” Being more perplexed than ever, I told John “Let me explain in terms I think you will understand.”

Let’s say the oilfield service company sells their service for $50 and has a resulting profit of $5. Now let’s say they have an opportunity for more business but do not have the capital (cash) to take on the jobs. So, would you agree they will not make any profits? John reluctantly responded with “Yes”. Let’s say the company has access to the capital (cash) presently locked up in their accounts receivable. Now, they can take advantage of their opportunity in the following manner. They still sell their services for $50 and now have a $3.50 profit instead of a $5 profit. In other words, your client will make $3.50 with me or $0 without me.

Before John had a chance to comment, the business owner said “I like your deal. Factoring can make me money.” Finally, John agreed, and the meeting moved forward.

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factoring, Situations Where Factoring Would Make or Save Money
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factoring, Situations Where Factoring Would Make or Save Money

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Compound Annual Growth Rate (CAGR)

See Also:
Price Earnings Growth Ratio Analysis
Value Drivers: Building Reliable Systems to Sustain the Growth of the Business
Income Statement
Balance Sheet
Cash Flow Statement

Compound Annual Growth Rate Definition (CAGR) Definition

The compound annual growth rate (CAGR), defined is the proportional growth rate from year to year for a business. It is essentially the geometric mean used to calculate the growth over a time period.

Compound Annual Growth Rate (CAGR) Meaning

Using the compound annual growth rate means that a company has the ability to measure any balance sheet items or income statement items year to year or can simply find an average over an extended period of time. By doing this the CAGR equation allows a company to remove the volatility from year to year and find a nice smooth average over a time period. It should be noted that the CAGR comes in use during larger time periods or periods without drastic outliers in the growth.

Compound Annual Growth Rate (CAGR) Formula

The Compound Annual Growth Rate formula is as follows:

CAGR = (End Period Value/Beginning Period Value)(1/# years) – 1

Compound Annual Growth Rate (CAGR) Example

Jerry is attempting to make some pro forma statements for his company. He decides that he wants to grow the predictions out for five years. He believes that the same amount of historical information is needed as well. Jerry also decides that he would like to grow all of his predictions by the sales growth rate. He finds that in Year 1 the growth rate was 5% and in Year 5 the growth rate was 8%. Jerry will calculate the CAGR as follows:

CAGR = (.08/.05)(1/5) – 1 = 9.86%

compound annual growth rate

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Company Life Cycle

See Also:
Dispersion
Capitalization
Market Positioning
Limited Partnership
Mergers and Acquisitions
Product Life Cycle

Company Life Cycle Definition

Broadly speaking, companies progress through a predictable series of phases called the company life cycle. The life cycle starts with the startup phase, moves into the rapid growth phase, followed by the maturity phase, and finally the last phase is decline. Furthermore, the duration of the individual stages varies widely across industries and differs between individual companies. As a result, the phases differ in terms of characteristics related to profitability and financing needs.

Stages of the Company Life Cycle

The startup phase is the first phase in the company life cycle. Companies in this stage are typically losing money, developing products, and struggling to secure a position in the marketplace.

Then the next phase in the company life cycle is the rapid growth phase. In this phase the company begins to generate profits. This phase is also characterized by rapid expansion and an increased need for and dependence upon outside financing to sustain the rapid growth.

The third phase is maturity. In this phase, growth and expansion is slow. Therefore, the need for outside sources of capital subsides. The company is generating enough profits and cash flows to invest in all available projects.

The final stage is decline. During this phase the company remains profitable but sales decline. The company has more cash than it needs for all available corporate projects.

Company Life Cycle Phases

The following includes the company life cycle phases:

1. Startup
2. Rapid Growth
3. Maturity
4. Decline

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company life cycle

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company life cycle

Source:

Higgins, Robert C. “Analysis for Financial Management”, McGraw-Hill Irwin, New York, NY, 2007.

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Value Drivers: Building Reliable Systems

See Also:
Value Chain
Valuation Methods
Responsibility Center
Cost Driver
Asset Market Value versus Asset Book Value

Value Drivers: Building Reliable Systems to Sustain the Growth of the Business

If your objective is to sell your company for the highest possible price, then you must build reliable systems that can sustain the growth of the business. Before we get started on discussing this important value driver, here are a few quick definitions:

  • Systems refer to a group of related processes.
  • Processes have purposes and functions of their own and are components of a system. Taken independently, a process alone cannot do the work of a system.
  • Procedures are the approved way we do things and often include a sequence of steps.
  • Steps are the actions we take to get something done. A solid management team is one of the first important value drivers to focus on when preparing your business exit. In addition to building a strong management team, you also must build reliable operating systems that can sustain the growth of the business. The second value driver is the development and documentation of business systems that either generate recurring revenue from an established and growing customer base or create financial efficiencies. For most businesses, this includes all of the core processes that generate revenue or control expenses. These systems may include processes related to production or service delivery. But it also may include people-related processes such as a succession planning or a performance management approach.

Look at your business from a buyer’s perspective. If you leave shortly after a sale, then what remains? If the answer is top management and highly efficient business systems, then you can be more confident that you will be able to get top dollar for your business.


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Business Systems Related to Customers

In addition to the business systems related to revenue and expense, some systems are related to customers, such as tracking systems, and the delivery of your products and services such as distribution systems. The documentation of these systems and their related processes and procedures is important to ensuring that quality and consistency can be maintained after the sale. They also signal to the buyer that everything is in place for their future success. Some examples of items worthy of documentation are:

  • Financial control systems and accounting policies.
  • Policies to ensure compliance with legal and regulatory matters, especially those related to employer/employee relationships and safety.
  • Data management and information systems that tie the company together

Again, put yourself in the shoes of a would-be buyer. Buyers want assurance that the business will continue to move forward after new ownership and that operations will not break down if and when the former management leaves. Obtain this assurance when there are documented systems in place that will enable the buyer to repeat the actions of the former owner to generate income and grow the business.

Examples of Business Systems

There are several business systems, which enhance business value whether you plan to sell your business now or decide to keep it. These systems include:

  1. Human capital management including: recruitment, selection, hiring, and retention; performance management; training and development; compensation and benefits.
  2. Production including product or service quality control and improvement.
  3. Product or service research and development.
  4. Inventory and fixed asset control.
  5. Sales, marketing and communications.
  6. Procurement including the selection and maintenance of vendor relationships

Obviously, appropriate systems and procedures vary depending on the nature of a business. But at a minimum, document those resources and activities necessary for the effective operation of the business. After you have built reliable systems to sustain the growth of the business, the next value driver to focus on is establishing a diversified customer base. We will discuss this value driver in detail in the next Exit Planning Review™ Article.

If you have any questions about increasing the value of your business prior to your exit, please contact us to discuss your particular situation. We can help guide you through the process of identifying the current value drivers in your business and creating a road map for increasing value to meet your overall exit objectives. Download the Top 10 Destroyers of Value whitepaper.

value drivers: building reliable systems

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Cash is in Your Business

See Also:
Cash Flow After Tax
Cash Cycle
Financing A Startup Company
How to Collect Accounts Receivable
Monetize
How to Develop A Daily Cash Report
Cash Flow Statement

Cash is in Your Business

I received a call from a desperate prospect, Sue. As always, I started asking questions about the business. To begin, I asked “Is your business growing?” She answered “Yes”. Then I asked her “What does your business need?” Frustrated she answered I NEED CASH. My next question was “Why do you need the cash, Sue?” Frustrated more than ever she replied “TO PAY MY BILLS!”

Two Sources of Cash

Seeing I was about ready to lose her in frustration I ask “Where does the cash come from in your business?” She responded calmly “What do you mean?” I responded there are two sources of cash for your business; internal and external. I continued by telling her we need to understand the cash source to determine and solve the problem. That is the only way we can ultimately get you the cash in the most cost effective way to satisfy your needs, paying your bills.

She then said “I still don’t understand your comment about internal and external?” I told her that internal cash flow in a growth business is generated by selling your goods or services at a profit. I then asked her what she sold in her business. She told me she manufactured products and sold them to large retail stores. I asked a couple more questions about her profit margins and satisfied myself that her margins were more than adequate.

A/R Collections

Then I asked her about her accounts receivable collection efforts and inventory management. She asked me “Why would you care about that?” Not waiting for a response she continued “I think I need a larger line of credit from my bank and they do not seem to be interested.” Increasing your line of credit with the bank may not be the most cost effective way to solve your cash flow needs. I asked her again about her accounts receivable collections and inventory management. Reluctantly, she told me that her receivables are past due, she is at her maximum credit line with her suppliers, and she does not have inventory controls.

Now that I understood her situation, I showed her that speeding up her accounts receivable collection process, and managing her inventory would allow her to get her suppliers back within their credit terms, and pay down her line of credit at the bank. The combination of these three results gave her the operating capital she needed to continue her growth for an estimated six months. Therefore, we could pursue external cash sources without the pressure of having to make a decision today. Start with knowing that cash is in your business.

For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.

cash is in your business, Sources of Cash
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cash is in your business, Sources of Cash

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Accretion

See Also:
Depreciation
Asset Market Value vs Asset Book Value
Fixed Asset Turnover Analysis
Research and Development
Straight-Line Depreciation

Accretion Definition

Accretion is the increase through time of a natural asset like land or a financial asset. The increases occur through growth and multiplication like through the following:

Meaning

Businesses often use this type of accounting for the development of assets in the form of an accretion expense, or an increase in the present value as the asset draws closer to its final future value. It is also used in Mergers and Acquisitions (M&A) when discussing the earnings per share for the company using pro forma statements after the transaction takes place. In other words, these accounts for the synergies which are likely to be realized. In addition, it will feed directly into the combined entity’s bottom line. Accretion real estate is simply the development of land through the growth and development of land. This can be through the development of a shopping center or something simple like the growth of livestock through breeding.

accretion

 

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