Speaker 1: Hey guys in today's video we're discussing four balance sheet KPIs that are used by financial analysts and investors to measure a company's financial leverage. But let's take a step back and define KPIs and define financial leverage. So KPIs are key performance indicators and these are ratios that we use as financial analysts to talk about the company's financials in a relative form. So rather than giving a dollar amount to someone we give them a KPI or a ratio. So for example if you're asked by an investor or by management to tell them describe the company's debt position. So you may give them the dollar amount of the debt. So you may say for example the company has two million dollars in debt or you can give them a KPI or a key performance indicator which will be a ratio that will give them more information. For example if the total debt that the company has is two million dollars so rather than saying that the company has two million dollars in debt you can give them a ratio like debt to equity ratio which in this case will take two million dollars of debt divided by the amount of equity. Say the equity is a million dollars and give them a ratio which would be two million divided by one million will be two. So that would be then an indication that the company has twice as much capital raised from debt than from stock issued. And so a KPI just has more information than just giving a dollar amount by itself. And in today's video we're talking about four KPIs that would measure a company's financial leverage. So let's first define financial leverage which is basically the strategy of the company to raise capital. So there are three main ways for a company to raise capital. One is through issuing debt most often in the form of bonds or issuing new stock to new investor or to existing investors. Or the third way would be to raise capital through its own operations from the free cash flow that the company generates from its own operations. And so those four KPIs that we will discuss today will give a new investor an idea on the mix of strategy that the company is using whether it's from debt or issuing stock or its own operation. So without further ado let's jump into today's video. And if you're new to the channel welcome my name is Bill Hanna. I've been in finance for the last 15 years. I started out with PricewaterhouseCoopers as an auditor and then I transitioned to a financial analyst role and then worked my way up to a controller position which is what I do now. And this channel is all about giving you the summary of my experience over the last decade and a half in finance. So if you're in finance yourself go ahead and subscribe to the channel and let's jump into today's topic. Okay so let's begin by looking at the balance sheet of the example company that we are looking at today. And this company is called Buy It Now Inc. If we look at the balance sheet just at a basic level the basic structure of the balance sheet is that total assets will equal total liabilities plus owner's equity. So in this case the company has 5.5 million in total assets and has 5.5 million in total liabilities and equity. And all of the KPIs that we will be looking at today are basically trying to measure one thing and one thing only which is if you look here at the total assets line 5.5 million dollars in assets. All of these KPIs what they're doing is trying to understand the leverage of the company how the company is financing this 5.5 million dollars in total assets. Is it through debt? So basically if you can look down here at the liabilities line the company has 3.9 million dollars in liabilities or through equity. So the company has 1.6 million dollars in equity. So these KPIs would be pretty much looking and trying to measure and give a quick to understand ratio of where the company stands in terms of the mix of strategy in terms of raising capital. So we'll begin by the first ratio here or the KPI that we're looking at today which is debt to equity ratio. And debt to equity ratio as the name implies is the relative proportion of shareholders equity and debt used to finance the company's assets. So basically it's looking at the amount of debt the company has and comparing it to the amount of equity and giving us a ratio that's easy to understand and digest. So basically if we follow the formula for this KPI it will be liabilities total liabilities divided by total equity. So in this example here total liability is 3.9 million dollars. If you divide that by total equity 1.6 million you get a ratio of 2.4 which is basically a ratio that tells us that the company uses 2.4 times that the company raises capital 2.4 times as much from debt as it does from equity. So this is not neither good or bad usually for manufacturing companies that ratio hovers around 2. And this ratio here being 2.4 isn't necessarily bad because in some cases the company is wanting to take advantage of low interest rates for example so it will rely more on debt to raise capital. Make sure to download our balance sheet metrics cheat sheet. It's 100% free and an amazing resource especially if you're a financial professional finance student or into stock investing. I'll leave a link in the description so go ahead and check it out and again it's 100% free. Now if we move on to the next KPI which is debt to capital ratio. And debt to capital ratio is a little bit similar to debt to equity ratio except it tries to measure the amount of debt the company has relative to the total capital deployed. So let's understand it more when we look at the formula you'll get it more. So if we look at the formula for debt to capital ratio basically the formula goes long-term debt divided by long-term debt plus equity which is basically what we are trying to compare by looking at the formula is the amount of debt compared to the total capital deployed in the company. So the long-term debt in this case is if you look in the balance sheet is two million dollars and if you take that and divide it by the total capital deployed which would be the same two million dollars from long-term debt plus equity which will tell us then two million dollars divided by 3.6 million or a ratio of 0.6. You can read it as 0.6 or 60 percent which is saying here that 60 percent of total capital raised is coming from debt. So basically this gives you an idea of how much of the total capital deployed in the company that comes from debt and is 60 percent. This seems to be fairly reasonable again it's neither here in this case good or bad you have to take it in context if the company is trying to take advantage of some favorable interest rates it might raise more capital or if the interest rates are high might be cheaper to issue stock so this here is 60 percent for the debt to capital ratio. Okay so far we've covered two KPIs the first one is debt to equity ratio and the second is debt to capital ratio and now the third KPI is going to be debt to assets ratio which basically is going to give you an indication of how much of the company's assets are financed through debt. So the formula for it would go if you look at the balance sheet here the formula is total debt divided by total assets that's the formula for the debt to asset ratio. So basically we're taking the two million dollars from total debt which is the long-term debt and dividing it by 5.5 million dollars in total assets and get a ratio of 0.4 or 40 percent you can read it either 0.4 or 40 percent which is basically saying that 40 percent of the company's assets are financed through debt. So now that we've covered three of the KPIs that we want to cover today we're on to the last KPI which is the financial leverage ratio which is very similar to the last KPI that we covered which was the debt to asset ratio but this one looks at it a little bit differently in terms of multiple so let's look at the formula and we understand it a little bit more. So if you look at the financial leverage ratio the formula goes total assets divided by total equity which basically if you look at the balance sheet here the amount of total assets is 5.5 million and the amount of total equity is 1.6 million and you can tell what this KPI is trying to do by dividing assets divided by equity is trying to say how much of the assets are supported by equity in the company. So basically here the multiple is the result of the ratio is 3.4 when you divide it so 3.4 you want that KPI to be as close as possible to 1 because basically when it's close to 1 it's saying that a lot of the assets of the company is supported by equity or ownership in the company but again if the company is leveraging more debt because the interest rate is low in the market so basically that could be a high number. So the answer is that it depends. Ideally you'll be close to 1 as much as possible but in this case we don't know if the company is trying to take advantage of low interest rates and so it's relying more on debt than equity to finance its assets. I'm going to go ahead and leave a link in the description of this video for you to download a summary of all those KPIs along with the calculation the formula and explanation of each one so that you can go ahead and download that and read it later and if you like the video and learn something new from it go ahead and smash that like button and if you haven't subscribed to the channel go ahead and subscribe now and I'll see you in the next video.