Return on Debt (ROD)
Meaning and definition of Return on Debt
The return on debt (ROD) can be expressed as the quantification of a company’s performance or net income as allied to the amount of debt issued by the company. Putting it other way, the return on debt refers to the amount of profit generated for every dollar held by a company in debt. As stated by Investopedia, the return on debt is an intricate financial modeling skill rather than being a commonly used financial reporting factor. Moreover, companies carrying a significant amount of debt relating to capital and/or assets are more prone to economic downturns during a decline in earnings and credit measures might be tightened.
Computing the Return on Debt
Being an evaluation of the company’s performance on the basis of amount f debt issued or borrowed, it can be calculated as the amount of profit generated with every dollar of debt wherein the company has issued as well as taken on. Unlike return on equity, which involves one line item representing the equity stake in the company, long term debt can be in various forms and at distinctive interest rates depending on the creditor or the issuer.
The key steps involved in computing the return on debt include:
1. Find the long term debt of the company. Long term debt can be located on the balance sheet as well as the notes to financial statements. The amount of long term debt explains how much debt is taken out or issued and the number years related to each.
2. Find the net income. Net income is generally the last line item on the balance sheet or the annual report. Specifically, the net income after tax is required for computation of return on debt.
3. Finally, the net income obtained is divided by the long term debt to obtain the return on debt.
Example for Return on Debt
To illustrate the working of return on debt, let us take the example of a company with a net income of $10,000 and long term debt (due over 1 year) of $100,000. The return on debt, therefore, would be computed as $10,000 / $ 100,000, which comes out to be 0.1 or 10 percent.