WHAT IS WRONG WITH THE EQUITY RATIO? 2 myths about Equity ratio and its quality
9. February 2024.NEGATIVE OPERATING CASH FLOW = SIGN OF TROUBLE?
17. February 2024.1) Increased interest expenses and outflows
If a business is financed through debt with variable interest rates, it will see an increased interest expense in the income statement and increased cash outflows in the cash flow statement.
This will negatively impact companies’:
- Net income
- All key cash flow metrics: FFO, operating cash flow, FOCF, FCF
- Debt Service Cover Ratio (DSCR)
- Interest cover ratio (ICR)
In essence, it reduces companies’ ability to generate cash flow and repay debt.
This is especially challenging for highly leveraged companies and those operating in low-margin industries.
2) Decreased value of long-term assets
The value of long-term assets like real estate, most securities, etc. will decrease as their future cash flows have to be discounted with higher discount rate.
This makes refinancing more difficult and more expensive, especially for those companies on the borderline with their collateral coverage.
Getting the same amount of credit lines could be challenging and might require alternative solutions.
The value of some long-term assets in the balance sheet will decrease (depending on accounting policies though), such as:
- Land, buildings, equipment
- Goodwill (in case it has to be impaired)
- Financial assets
This will impact the capital structure ratios:
- Equity ratio
- Debt-to-Capital ratio
- Tangible Net Worth (TNW) ratio
It is the main reason why we have been increasingly seeing real estate companies recording huge losses.
3) Decreased demand
Higher interest rates lead to lower disposable income, which leads to lower consumption. Further, as money is getting more expensive and demand decreases, companies reduce capital spending, and the vicious cycle continues.
As more companies suffer, the bad debt increases, which impacts mostly your:
- Revenue
- Profitability metrics: EBITDA, EBIT, net income
- Cash flow metrics: FFO, NOCF, FOCF, FCF
Virtually all financial statements and metrics are impacted by decreasing demand.
________
The list above is not exhaustive, there are many other items which will be impacted, depending on the company’s industry, business model, leverage level, etc.
However, the common denominator is that it will impact companies’ LIQUIDITY.
Be sure that your customers have enough.
Make sure your company has enough.
________
CreditAnalyst(.eu) – Company Analyses | Negotiations with Banks | Financial Planning
