This ratio is an aspect of surety underwriting that is important because it can affect the availability of both surety bonds and bank credit. Let’s learn about it.
The company Balance Sheet (BS) is a one-day snapshot of the money in the company (Assets), and who owns it (Liabilities.) It is the same money viewed from two different directions.
The last section on the liabilities side is the Net Worth (may be called Stockholders Equity.) It is the portion of the asset dollars owned by the founders and investors of the company.
The Total Liabilities shows the amount of the assets dollars owned by 3rd parties creditors, such as the bank (mortgage or equipment loans) or suppliers on accounts payable.
D:E stands for Debt to Equity. It measures the balance between these two groups of creditors. As the 3rd party creditors increase, the company becomes “more leveraged,” less creditworthy. Eventually the banker will say, “We can’t give you a loan because you are already carrying a lot of debt.” The surety underwriter may say “The Net Worth is too low.” It’s means the same thing…
Next question: What is an acceptable D:E Ratio? When is it not a problem?
Analysts generally look for a ratio not in excess of 3:1 or maybe 4:1.
At 4:1, the Total Liabilities would be 4 times greater than the Net Worth.
The D:E Ratio a sign of financial health and successful management. All analysts use it, and it’s easy to “eyeball.” Get in the habit of checking it, and you may see some wild numbers – a very good or a very bad sign! Good to know.
Are we Surety Bond Geeks? Well, we love this stuff so. . . .
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