Debt to Tangible Net Worth Ratio
Debt to tangible net worth ratio is the ratio measure the lender’s protection if the company when bankrupt. It is the comparison of a company’s total liabilities to owner equity (shareholder equity) exclude any intangible asset.
The lender wants to access the company’s assets which will be sold to settle the debt in case of insolvency. Intangible assets are excluded from the calculation as most of them are not worth anything when they file for bankruptcy. To eliminate the intangible assets will measure the company’s real ability to pay off the debt.
Debt to Tangible Net Worth Formula
| Debt to Tangible Net Worth = Total Liabilities / (Shareholders’ Equity – Intangible Asset) |
Example
For example, base on company A’s balance sheet on 31 Dec 202X, shareholder equity equal to $ 100,000, and total liabilities are $ 60,000. Moreover, the company-owned some intangible asset such as:
| Description | Amount |
|---|---|
| Goodwill | 10,000 |
| Patent | 8,000 |
| Software | 12,000 |
Debt to tangible net worth = 60,000 / (100,000-10,000-8,000-12,000) = 85%
It means that if the company when bankrupt, there will be 1 dollar worth of tangible assets for every 85 cents of debt.
Advantages
Easy to calculate
The ratio is simple to calculate without any complicated skill. The required data is available in the balance sheet. We do not need to extract from the system or any other software. Accountants just take the figure from the balance sheet and make the calculation.
Easy to compare between industry
It is the universal formula, so it enables the lender to compare between the company and lend the money to a low-risk company. Due to limited funds, lenders will need to make precise decisions, so they will prefer low-risk companies.
Disadvantage
Rely on book value
The value of assets in this calculation brings from the balance sheet that may be the historical cost method which is not the actual price if the company files for bankruptcy. These assets will be sold at a different price if compare to the historical cost. The ratio will be misleading as it not represent the actual amount that the lender will receive in case of insolvency.
No standard rate
There is not a target ratio that represents the standard rate for each industry. Different companies have different ratios depending on their level of debt compare to equity and intangible asset.