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Computerized Investing > Third Quarter 2010

Analyzing Debt Ratios

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by CI Staff

Companies report the generation and use of cash from three basic activities: cash from operations, selling assets and investments, and the financing sources of issuing new shares and taking on debt. Most companies use a combination of the three, sometimes relying more heavily on one type over another as they move from growth and expansion to a more mature company. This column focuses on the use of borrowed funds. Knowing the debt level of a company can help you more fully understand how the company structures its finances and whether it can continue to operate.

When used properly, debt can allow a company to earn a higher level of profits for a given level of owner equity. However, interest on debt must be paid whether or not a company is profitable, so too much debt may force a company into bankruptcy if cash flow dries up. In addition, the market’s appetite for debt can change over time, making it more difficult and expensive to borrow.

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