What are Total Assets?
Total assets refer to the sum of the book values of all the assets owned by an individual, company, or organization. It is a parameter that is often used in net worth debt covenants. The value of a company’s total assets is obtained after accounting for depreciationDepreciation MethodsThe most common types of depreciation methods include straight-line, double declining balance, units of production, and sum of years digits. There are various formulas for calculating depreciation of an asset. Depreciation expense is used in accounting to allocate the cost of a tangible asset over its useful life. associated with the assets. Net worth, in the simplest terms, is the equivalent of total assets minus total liabilities.
What are Debt Covenants?
Debt covenants are basically promises or agreements by the borrowing party to comply with the terms agreed upon while discussing the loan agreementCommercial Loan AgreementA commercial loan agreement refers to an agreement between a borrower and a lender when the loan is for business purposes. Every time a substantial amount of money is borrowed, an individual or organization must enter into a loan agreement. The lender provides the money, provided the borrower agrees to all the loan stipulations. They are generally restrictions or limitations imposed by the lending party that the borrowing party agrees to in exchange for a loan. In other words, these are certain benchmarks that the borrowing party agrees to adhere to in exchange for a loan. They are also generally referred to as “bond covenants.”
Total Assets: Use in Debt Covenants
Hence, total assets is an important and integral component of net worth debt covenants. The covenants are measured via the balance sheetBalance SheetThe balance sheet is one of the three fundamental financial statements. These statements are key to both financial modeling and accounting. The balance sheet displays the company’s total assets, and how these assets are financed, through either debt or equity. Assets = Liabilities + Equity of the borrowing party. Net worth debt covenants are most commonly in use when the lending party is a commercial bank or financial institution. Some common examples of net worth debt covenants can be total assets to debt ratioDebt to Asset RatioThe debt to asset ratio, also known as the debt ratio, is a leverage ratio that indicates the percentage of assets that are being financed with debt., total net worth to debt ratio, minimum net worth, and many others.
For example, ABC Ltd. applies for a loan with XYZ Bank Ltd. for $800,000. After evaluating ABC Ltd.’s financial statements and credit history, XYZ Bank agrees to grant the company a loan for $800,000, provided the latter agrees to certain terms and conditions included by the bank in the loan agreement.
While evaluating the company’s financial statements, the bank noticed that the organization sold off a considerable value of its assets in the past financial year to settle a long-term loan. However, projections for the upcoming financial year showed a positive trend. Hence, the bank included a condition that it would lend to the company provided the latter maintains a minimum net worth of $1,000,000 for the duration of the loan. The above is an example of a net worth debt covenant.
Additional Resources
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certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:
- Loan AnalysisLoan AnalysisLoan analysis is an evaluation method that determines if loans are made on feasible terms and if potential borrowers can and are willing to pay back the loan. It checks the eligibility of the potential borrower against the criteria set forth for lending.
- Tangible Net WorthTangible Net WorthTangible net worth is an estimate of the net worth of an entity that excludes all intangible assets such as patents, trademarks, and intellectual property,
- Types of AssetsTypes of AssetsCommon types of assets include: current, non-current, physical, intangible, operating and non-operating. Correctly identifying and classifying assets is critical to the survival of a company, specifically its solvency and risk. An asset is a resource, controlled by a company, with future economic benefits.
- Valuation MethodsValuation MethodsWhen valuing a company as a going concern there are three main valuation methods used: DCF analysis, comparable companies, and precedent transactions. These methods of valuation are used in investment banking, equity research, private equity, corporate development, mergers & acquisitions, leveraged buyouts and finance
