‘Return On Debt’. Spells short. But it’s as important as any other financial ratio, and also tells a lot about the financial health of a company. Especially when there are big number of debts that peeps out of the balance sheet. So easy to analyze, but difficult to manage, ROD ratio has its own impact on any company’s performance.
Let’s try to have a few important points – What it may otherwise indicate the impact of ROD on any company’s performance as well as on our returns.
What Is ‘ROD’ Or The ‘Return On Debt’ Ratio
The ROD is a financial ratio, that compares the company’s net earnings to its long-term debt.
‘Return On Debt’ = Net Earnings / Net Long Term Debt
Here, debt means either taken /issued by the company. And sometimes the both the cases. And this ‘long-term-debt’ is in various forms and in distinctive interest rates depending on the creditor or the issuer. Anyhow, what we need to calculate is the ratio of the net earnings of the company to its net debt.
This ratio shows the amount of net earnings that is generated, for each coin that a company holds in debt. And, this ROD can either be positive /negative.
A positive ROD has been always beneficial to the company. And, it indicates that some income is being generated by the debt issued /taken by the company. Where as a negative ROD is a threat.
We can locate the long term debt data on the balance sheet as well as the notes to financial statements. The information explains the amount of debt taken out /issued and the number of years related to it.
How Important Is ‘Return On Debt’ In Any Company’s Financial Analysis
Mostly, the ratio of ‘ROD’ is not used in the simplest financial analysis. But, it’s an important calculation that needs to be performed, while evaluating company’s solvency. It is generally used by the owners of the company while making a decision on, which financing sources would be better for the company.
It’s common to carry a certain amount of debt by any company. But, the amount should be limited. The more the debt to its earnings level, the more the credit risk’ is.
Moreover, companies carrying a significant amount of debt related to capital and/or assets are more prone to economic downturns during a decline in earnings.