Asset Coverage Ratio

  

So, you just took out a second loan on your home and pledged it to buy that cabin in the woods you can't afford? Your debt now exceeds your assets. Oops. That's a simple, yet important example of a crappy asset coverage ratio.

Now let's apply that to business. When you take out a company loan, your bank will want to know your asset coverage ratio to make sure you can afford that loan. An asset coverage ratio is used to figure out how your assets stack up to your debts. The higher the ratio, the better. The formula for asset coverage ratio is as follows: (Total Assets-Intangible Assets) - (Current Liabilities-Short Term Debt)/Total Debt Obligations. An asset is something the company owns that carries tangible value-like patents, 1400 acres of fully leased server farm, distribution networks with 6,000 bars, $14 million in cash in a Wells Fargo account, etc. All of those are assets that banks will go after, should you default on your promise to pay them back the money you borrowed.

Related or Semi-related Video

Finance: What is Loan To Value (LTV)?3 Views

00:00

Finance allah shmoop What is the loan to value ratio

00:06

or ltv All right Well this is the value of

00:11

your house for hundred grand This is your down payment

00:15

one hundred grand And this is your loan of three

00:20

hundred grand loan to value Yeah It's a fraction easy

00:25

Three hundred grand over four hundred grand or three over

00:28

four or seventy five percent Well what does that mean

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Like why do we even care about loan to value

00:34

ratio Well because they speak volumes as to how risky

00:37

the loan is to the bank or whoever is lending

00:41

the dough in this transaction Should you know things go

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awry like you get hit by bus and you can't

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pay it back How does a bank it's loan back

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So you want a low loan to value ratio if

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you're the lender because well the worst thing that happens

00:56

is that you repossess whatever the asset was that was

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pledged as collateral against a loan You just sell it

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to somebody else So what are the odds You could

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get your money back if you're the bank who loan

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three hundred grand against a home that just sold for

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four hundred grand Could you drop the price tow three

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eighty and then pay twenty thousand dollars in realtor costs

01:14

and all the stuff that goes with it And then

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you're down to three sixty and maybe there's some other

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costs and their ten grand or so you get all

01:21

your three hundred thousand dollars loan back and probably fifty

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grand to boot and in theory that might go to

01:26

the cellar but it probably all go to the banks

01:28

lawyers So this equation works great with homes because over

01:31

time holmes generally go up in value knock down because

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there's more people coming onto the earth again and again

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just checked global warming if you're curious about that So

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holmes worked great for mortgages and generally accrue lower loan

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to value ratios over time But how does this work

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when you take out a car loan Yeah cars are

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essentially never an investment They're just a money pit They

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just go down in value So you really wanted that

01:59

forty two two thousand dollars convertible prius with the turbo

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charging battery which gave it a zero to sixty rating

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of seven point eight seconds rather than the standard prius

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Rating zero to sixty of just yes problem You put

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ten thousand down and borrowed thirty two grand on what

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you hoped would be a five year loan Unfortunately six

02:19

months after you drove off the lot the market value

02:21

of your turbo prius is only something like thirty thousand

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dollars maybe less And in that time period you've only

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paid four thousand dollars of principal down on your loan

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So you still owe twenty eight thousand bucks on an

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asset that today would sell form them maybe thirty and

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after commissions transaction costs and lawyer hassle Well it'd certainly

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be worth less than that much money toe whoever had

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to repossess the car and then sell it that's why

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they charge you so much interest rate on car loans

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and only can't blame him Cars suffer this very difficult

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loan to value equation all the time and it's part

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of the reason that car loans air made so difficult

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especially when you go through a dealer and why they

03:03

push you hard to put down a whole lot of

03:05

money up front So the big idea here hi l

03:07

tvs are bad low lt v's are good lenin doubt 00:03:11.5 --> [endTime] Go turbo

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