You run IHeartCholesterol, a 100-store pizza chain. You have no debt and small cash amounts. You have used extra cash historically to buy or open additional pizza parlors.
But now along comes MetabolismKillers, a chain of 40 pizza parlors. They want 20 million bucks for you to buy all of them, and the parlors themselves currently produce each year about a million bucks in cash. You think that, with your buying leverage of cheese and dough and oven rentals, you could make the acquisition produce cash flow of a million-and-a-half bucks in Year One just by virtue of lowering expenses on volume purchases of the stuff you put on the pizzas.
Minor problem: You don't have 20 million bucks laying around. Your own existing business has cash flow of about $3 million a year. Combined, you'd have $4.5 million a year in cash flow, and that should be enough to quickly pay off the Acquisition Financing of $20 million you want to raise from your kindly loving bankers, who are all too happy to loan you the money at onerous terms.
If things go well, you grow great; if they don't, the financiers likely take ownership of your pizza chain and all your hard work is wizzed away, like the soda you drank three hours ago.
Related or Semi-related Video
Finance: What is the Debt to Equity Rati...18 Views
Finance allah shmoop shmoop What is the debt to equity
ratio or duras It is named in insane asylums all
over the world Well it's a balance sheet computation that
tries very roughly to measure how efficient a company is
using its precious capital resource is the numerator comprises long
term liabilities on ly For most companies with debt the
amount of long term debt vastly outweighs the short term
So they ignore the short The denominator is the company's
shareholder's equity Easy You know that computation right ale and
think that's the capital invested in the business that's what
Isthe so what does it mean to have a high
durer Well if shmoop a loops llc a producer of
the most delicious cereal on the planet has four billion
dollars of debt And on lee fourteen dollars of equity
will you don't have to be a wall street genius
to get that that's bad right Tons of debt almost
no equity It means that loans comprise some ninety nine
percent of the company and well that it is essentially
owned by the bank and other creditors not by the
equity stake holders And you want steak Flip things around
Your cisco networks with a billion dollars of debt and
like fifty billion dollars of equity Well the shareholders clearly
owned this company The size of the equity dwarfs the
size of the debt Got it Bottom line High ratio
bad low ratio Good at least if you're one of
the owner investors But if you're a banker with a
hankering to own a cereal company well then today you 00:01:33.338 --> [endTime] might be able to just take one over girls
Up Next
An MBO is a Management Buy Out (a buy out by inside management); an LBO is a Leveraged Buy Out (taking on debt to buy a company).
What are Debt Service and Debt Service Ratio? Debt service is the amount of funds needed by a borrower to successfully cover interest and principal...
What is Debt-to-EBITDA? Debt to EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) is a ratio that calculates Debt to net earn...