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Asset coverage has to do with the ratio between the tangible assets that are in hand and the amount of money that is owed in the way of loans, and other debts to vendor partners, preferred stock holders, and others. When discussing the current level of asset coverage, the point is to determine how much of the net assets of the company would be necessary to cover the current outstanding indebtedness of the business.
The process for calculating asset coverage is very simple. First, determine the sum of the equity in the business and the non-current liabilities that are held by the company. Divide this figure by the value of non-current assets. The answer will be the current rate of asset coverage, as calculated into a percentage. In some instances, the value of inventories may also be bundled in with the value of the non-current assets as part of the final calculation.
Keeping a close watch on asset coverage is a smart move for businesses of all sizes. While it is virtually impossible to run a company without some sort of debt incurred, the goal is to make the best use of all resources at hand. Keeping a watch on the ratio between assets and liabilities using the asset coverage formula is one way of making sure this wise use of resources is occurring. A good asset coverage ratio also means that any debt obligations that are incurred as part of the operations of the company can and will be repaid in a timely manner.
Along with providing valuable insight into the financial health of the business, the process of determining asset coverage also requires that financial records be current and accurate. It is impossible, for example, to determine the current status of debt obligation unless the Accounts Payable information is complete and up to date. In like manner, it is important to account for each net asset of the business in order for the asset coverage formula to produce a correct and helpful snapshot of the finances of the company. Thus, a byproduct of asset coverage calculation is that all the financial records must be maintained in order for the data to have any constructive meaning.
Asset coverage calculations are a process that every company should engage in on a regular basis throughout the fiscal year. Taking the necessary data and determining the percentage of debt compared to assets is a great way to ensure that the company is moving forward, as well as to alert the owner to a need to make some changes in order to maintain the profitability of the business.
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