Guidance and Knowledge for Value Investors
The amount paid for the use of capital as borrowed funds is called interest. This is very similar to rent. With rent, the capital is the fixed asset and the rent is the amount of interest paid to use the fixed asset during the time period.
Almost every small business borrows money. The most common reason is to purchase a fixed asset of some sort. The amount borrowed is most often a long-term liability. There are several steps involved in recording the original loan and then processing the respective payments.
The last of the leverage ratios isn’t really a pure leverage indicator but augments the debt ratio. Debt requires the payment of interest and so an indicator of the ability to pay this interest is needed. This is the interest coverage ratio.
A quick and easy way to determine the doubling of value for a given sum based on an interest rate is the Rule of 72. This simple formula has three factors. The first is the interest rate; the second is the amount of time in years to double the value and of course the number 72.