5 million debt has a company or a community, sounds a lot. But this exemplary sum does not provide information about the debt of a company, a municipality or a state. Rather, one needs the degree of debt, too gearing, However, the degree of debt is not only composed of the debts as a whole, but other economic figures also play a role here. These include, for example, revenue, or more precisely, the profit that is generated. The latter is decisive since, after deduction of all expenses, Equity and can also be used to pay debts. In financial terms, the debt ratio is determined by the ratio between debt and equity.
Differences in the degree of debt
In addition to the normal degree of debt, there is still another variation. This includes, for example, the dynamic debt ratio. The calculation of the debt is not based on equity, but on the cash flow. Of course, the question arises, why must one determine the degree of debt at a company, a municipality or a state? This is mainly due to financing. It is often necessary to finance loans from banks and financing companies. Of course, they want to keep the risk of a credit loss as low as possible. However, financial statements or the like often give little information on the actual state of finances. Just because it is often only snapshots limited to one year and the overall overview is missing. By providing information on the degree of debt, banks can assess whether a further loan and the resulting repayment and interest rates are also feasible. the higher the degree of debt, the less free capital a company or a municipality has. As a result, the liquidity decreases as well, which can lead to the fact that further loans are no longer or no longer at the desired level. And even if banks are still lending, they may have high interest rates or require collateral. What can ultimately develop into a devil's circle, since this can lead to a further increase in the level of debt, which then has a negative impact on the sustainability of debt and on liquidity.
Can have serious consequences as upper limit
However, the degree of indebtedness can not be neglected in other respects. If, for example, financing contracts already exist, the upper limit for debt may be set. This is formulated in a debt-to-equity ratio. If this level is exceeded, this can have serious consequences. If it is the object of a contract, it is a breach of contract. Usually the financing contracts are terminated after a short period of time to reduce the debt. Here, then, the extraordinary right of termination, which then results in all credit claims being due directly to payment. As can be seen from this, the degree of debt can not only provide a degree of information but also an integral part of a contract. Therefore, companies are therefore generally concerned to keep the debt level as low as possible.