How are you managing your “debt capital”?

By: Dennis Gardiner, CPA, Partner  |  email

Debt capital is your borrowed funds.  The amount of debt on your company’s balance sheet is a critical number.  Typically a sign of success is when a balance sheet shows the amount of long term debt decreasing for one or more years.  Too much debt can be a strain on earnings, and a sign of a struggling company.  That said, debt used to fund profitable growth can drive greater earnings for your company.  The challenge is to figure out how much debt is too much.  This can be further complicated by the wants and needs of the board of directors.  The younger members may resist the reliance on long-term debt, choosing to fund growth through member’s equity.  Alternatively, the older board members may be looking at wanting to ensure that they will be able to have their equity paid, revolved or retired to them when they hit the organization’s prescribed ages or dates.

Along with other ratios, a couple of the gauges to help measure whether a cooperative has borrowed too much money are the Debt-to-Equity Ratio and the Debt-to-Local Equity Ratio.

The debt to equity ratio compares the amount invested in the business by creditors with that invested by members. The higher the ratio, the higher the creditors’ claims on the assets, possibly indicating the cooperative is extending its debt beyond its ability to repay. However, an extremely low ratio may indicate that the cooperative is managing its assets too conservatively.

Similarly, the debt to local equity ratio makes the same comparison but eliminates investment in regional cooperatives from what the coop members have invested.  This is done since the members, in theory, can’t get at that equity, since it is only available to them at the discretion of the regional cooperatives.

A typical benchmark for the Debt-to-Equity ratio would be 40-50%, and a benchmark for the Debt-to-Local Equity ratio would be 50-60%.
With their success throughout the last several years, and by retaining the benefits of the Section 199 deduction (DPAD), our clients have very good debt-to-equity and debt-to-local equity ratios.  The following is an average of what we have seen over the past three year period:

So, how does your cooperative match up?  Every coop is different, and again as mentioned earlier, if the increased debt is driving enhanced earnings, it is not a negative indicator, to be higher than the ratios noted above.  If you’d like to discuss ways to evaluate or manage your debt and equity capital, we’d be happy to speak with you.