Debt ratio can help investors analyze the company’s ability to pay the principal and interest on outstanding debt. These ratios reveal how companies finance their asset purchases and their ability to withstand economic turmoil. They also indicate whether the company is using debt responsibly to develop its business, or is overly dependent on debt to meet core obligations. The latter may mean trouble in the near future.
Certain debt ratios should be compared with benchmarks, while other debt ratios are more subjective and compare better with industry peers and the broader market ratio. For large retailers such as Wal-Mart (WMT), the most reliable debt ratios are debt-to-equity ratio, interest coverage ratio, and cash flow to debt ratio.
- Investors use debt ratios to analyze how companies finance their asset purchases and the company’s ability to repay outstanding debts.
- The three debt ratios commonly used to evaluate a company are debt-to-equity ratio, interest coverage ratio, and cash flow debt ratio.
- A high debt-to-equity ratio indicates that the company relies on debt rather than equity to finance its asset purchases.
- As of October 31, 2020, Wal-Mart’s debt-to-equity ratio was 1.87, a figure indicating that the company is using more debt than equity to finance its asset purchases.
Debt to equity ratio
The debt-to-equity (D/E) ratio compares the percentage of a company’s debt-financed assets to equity financing. It is calculated by dividing total liabilities by total shareholders’ equity. A high D/E ratio indicates that the company is more leveraged and relies more on debt to finance asset purchases. Although the use of leverage is not inherently a bad thing, using too much leverage can put the company in a dangerous situation.
As of October 31, 2020, Walmart’s D/E ratio is 1.87.This is a healthy number and has been very stable for the past ten years. This shows that the company is using more debt than equity to finance asset purchases, but its debt management practices have not wavered for several years, and even in times of economic turmoil, the company has not used too much debt.
Compared to its main competitors, Wal-Mart has a low D/E ratio, with Target’s ratio being 2.8 in the fiscal quarter ended October 31, 2020.
Interest coverage ratio
The interest coverage ratio measures the number of times a company can use its current earnings to pay interest on its outstanding debt. It is calculated by dividing profit before interest and taxes (EBIT) by interest expense.
The high ratio means that the company is unlikely to default on debt in the near future. Most analysts agree that the absolute minimum acceptable interest coverage ratio is 1.5, although value investors prefer companies with significantly higher numbers.
Walmart’s interest coverage ratio for the third quarter of fiscal 2020 was 10.7.Walmart’s interest coverage ratio began to decline sharply in 2017, then bottomed out at the end of 2018, and then rebounded to a multi-year high in January 2021. The decline was due to the decline in profit before interest and taxes. For Target, the interest coverage ratio for the same quarter was 3.1.In the first nine months of 2020, Wal-Mart’s interest coverage ratio was 9.5. At the same time, Target was 5.4 during the same period. In general, Wal-Mart has more profit before interest and taxes to cover interest expenses.
Cash flow to debt ratio
The ratio of cash flow to debt is calculated as operating cash flow divided by total debt, which measures the percentage of total debt that the company can pay with current cash flow. This is an effective indicator to be considered together with the interest coverage ratio, because it only includes income that is actually realized in the form of cash.
This indicator is best calculated using annual data. Therefore, in the 2020 fiscal year (as of January 1, 2020), Walmart’s cash flow to debt ratio is 0.58, which means that its annual current operating cash flow can cover 58% of its debt.It is very important to see this trend as an indicator of the company’s commitment to responsible debt management in the future. Target’s cash flow to debt ratio for fiscal year 2020 (as of February 1, 2020) is 0.63.