What Is Return On Debt (ROD)?
Return on debt (ROD) is a measure of profitability with respect to a firm's leverage. Return on debt shows how much the usage of borrowed funds contributes to profitability, but this metric is uncommon in financial analysis. Analysts prefer return on equity (ROE) or return on capital (ROC), which includes debt, instead of ROD.
Understanding Return On Debt (ROD)
Return on debt is simply annual net income divided by average long-term debt (beginning of the year debt plus end of year debt divided by two). The denominator can be short-term plus long-term debt or just long-term debt. Suppose a company has a net income of $50 million in a year. If its average debt amount was $1.5 billion, return on debt was 3.3%. This number would have to be placed in context. Was that ROD higher or lower than the last period? Were there any nonrecurring items on the income statement that distorted net income during the period? Was there a change in the tax rate that caused an unusual movement in net income? In addition, if there is a material cash balance, it could be netted against the debt figure to derive a variant, return on net debt. This may be of more analytical value as a return metric.
ROD vs. ROE and ROC
ROD is less interesting than ROE and ROC. ROE, net income divided by shareholders' equity, is followed by investors who want to know how well management deploys shareholder funds. ROC, net income divided by shareholders' equity plus debt, is a more comprehensive measure of management's ability to deploy total capital in pursuit of profits. As for ROD, the components for these two preferred measures must be examined to make sure the figures are clean.