Debt to Tangible Net Worth Ratio – a ratio indicating the level of creditors’ protection in case of the firm’s insolvency by comparing company’s total liabilities with shareholder’s equity (excluding intangible assets, such as trademarks, patents etc.).
This is a more conservative indicator comparing to debt to equity ratio, because intangible assets not always have value when a company is going through the process of liquidation. For instance, if the trademark is not planned for use by any of other firms, its value would equal zero. In this case funds obtained from intangible assets sale can't be used for covering the liabilities to creditors. Eliminating intangible assets from computation is very important for analysts in terms of measuring the real debt-paying ability of a firm.
Generally, excess of the debt to tangible net worth ratio value over 1 means than company's creditors aren't well protected, and in case of firm's insolvency they would only recover a part of the principal and interest belonging to them. Lower than 1 ratio indicates the situation when creditors can expect receiving all the amount in full (principal plus interest).
Debt to Tangible Net Worth Ratio = Total Liabilities ÷ (Shareholders’ Equity - Intangible Assets)
Debt to Tangible Net Worth Ratio (Year 1) = 464 ÷ (853 – 334) = 0,89 = 89%
Debt to Tangible Net Worth Ratio (Year 2) = 911÷ (1724 – 461) = 0,72 = 72%
If company went bankrupt in year 1 there would be 1 dollar of tangible net worth for every 89 cents of debt. This indicated a good level of creditors' protection in case of firm's insolvency, because selling tangible assets was enough to meet company's obligations to creditors. In year 2 the ratio decreased to 0,72, which was a positive trend.
Debt to tangible net worth ratio provides the lender with an analytical base for making a decision on how much can be loaned to an analyzed company. It is more conservative than debt to equity ratio, because it takes into account only easily quantifiable net worth and eliminating all unquantifiable intangible assets. For a lender it does not make sense to provide a company with a loan, exceeding 100% of it tangible net worth. Different companies have different policies regarding the benchmarks in determining the credit limit. Generally, providing other company with a loan more than 50% of its tangible net worth means high risk of not recovering the whole amount of the loan and interest in case of the firm's insolvency.