Return on debt (ROD) is a term that is utilized in several different scenarios, and typically has to do with the benefits that a company receives on the amount of debt that is currently held. The idea is to determine if those benefits are sufficient to continue holding that amount of debt, or if the company would do better to adjust the amount of debt that is held, especially in light of the amount of revenue that the business is currently generating. The return on debt may be positive, serving as an indicator that the relationship between revenue production and debt is beneficial to the company. The ROD can also be negative, indicating that company officers should take action to reverse the current trend before the business sustains long-term damage.
In some applications, return on debt focuses on how well the debt that has been taken on is aiding the company in generating revenue. For example, if a manufacturing plant purchases new equipment for the production floor and finances that purchase, the business has taken on debt with the expectation that doing so will increase revenue. Assuming that the machinery does make it possible to produce higher quality goods more efficiently, and the company is able to attract additional customers, this means that debt created by the purchase does in fact result in the benefit of additional revenue. By using a specific formula to calculate the return on debt, it is possible to associate the amount of that revenue with the amount of debt that remains on that new machinery and determine the actual amount of benefit achieved.
A return on debt may apply in a number of business settings other than purchasing new equipment. The same approach can be used to determine if the debt taken on by opening a new sales office, buying out a competitor, or even choosing to borrow money that is invested in a new product venture is actually to the benefit of the business. At its core, the return on debt is a measure that helps to identify if there is any benefit to carrying the debt, or if the debt load is threatening to undermine the operation and drive the company closer to bankruptcy or a complete shutdown.
Typically, companies run a greater risk of financial issues if more debt is carried during an economic turndown. By using a process to calculate the return on debt regularly, such as once a month or at least once per quarter, it is possible to identify changes in revenue levels that may point toward a brighter future for the company or serve as a warning that changes need to be made immediately if the business is to survive. By taking the time to determine the return on debt, company officers can have a better idea of what needs to change in terms of debt management, and possibly even identify some ways to make the operation more efficient and increase the amount of net revenue that is realized.
