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The Daily Technical #78: What is the difference between a write-down and a write-off?

How to answer "What are the two types of credit ratios used to assess a company's default risk?"

December 27, 2024

Good morning. Welcome to the 78th edition of The Daily Technical. You’re here for one reason so let’s dive in.

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OVERVIEW OF YESTERDAY’S QUESTION
What are the two types of credit ratios used to assess a company's default risk?

To assess a company's default risk, focus on two credit ratios: leverage ratios and interest coverage ratios.

Leverage ratios determine the level of debt in relation to specific financial metrics, usually EBITDA. Key examples include:
- Total Debt/EBITDA
- Senior Debt/EBITDA
- Net Debt/EBITDA
- Total Debt/Equity
- Total Debt/Total Capital

Interest coverage ratios evaluate a company's capacity to meet interest obligations with its cash flows. A higher ratio indicates better safety, typically aiming for over 2.0x. Relevant examples are:
- EBIT/Interest Expense
- EBITDA/Interest Expense
- EBITDA/Cash Interest Expense
- (EBITDA – Capex)/Interest Expense

Common Mistakes

  1. Confusing leverage ratios with interest coverage ratios. Leverage ratios evaluate debt against cash flow metrics like EBITDA, while interest coverage ratios assess a company's ability to pay interest.

  2. Mixing up different formulas within the same category, such as Total Debt/EBITDA versus Total Debt/Equity. Knowing the specific numerator and denominator in each formula is crucial.

  3. Not mentioning the significance of ratio values might undermine the analysis. For example, interest coverage ratios should ideally exceed 2.0x to suggest financial stability.

TL;DR

  • Leverage ratios assess debt against financial metrics like EBITDA. Key examples: Total Debt/EBITDA, Net Debt/EBITDA.

  • Interest coverage ratios evaluate ability to pay interest using cash flows. Higher ratio means better safety; aim >2.0x.

TODAY’S QUESTION
What is the difference between a write-down and a write-off?

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THAT’S A WRAP
See you Monday,

Mike Lukasevicz
Founder @ HirePrep