We often hear terms like the assets of the company being charged to the lender, this article on glossary of debt shall briefly describe some of the distinguished features of charges and its ranking. Also, we see how a high or low debt to equity ratio is so important in the event of liquidation.

When a company asks a bank for a loan, the banker will seek certain collaterals or security from the company like land, building, plants and machinery, current assets, etc. The assets become collateral or security to the loan made by the bank.

Charges therefore represent security that a bank has in making a loan.

Charges can be:

• A fixed charge where it refers to a specific asset e.g. building or plant. In the event of default, the lender can take control of the asset and sell it to cover the value of the loan.

and

• a floating charge refers to all the assets of a business over which there is no fixed charge.

In the event that the company who took the loan is unable to pay the bank, than the ‘RANKING” which refers to the orders in which the holders(lenders) of a company’s securities are paid out in the event of liquidation.

The order is as follows:

1. preferred creditors ( Inland Revenue, Statutory Boards , wages and salaries up a certain limit )
2. holders of fixed charges over the assets ( ie mortgagees)
3. holders of floating charges over the assets ( ie debenture holders)
4. senior creditors like the trade creditors and unsecured debt
5. subordinated creditors such as holders of unsecured loan stock
6. holders of preference shares
7. ordinary shareholders.

To the lender the debt to equity ratio plays an equally important part besides the earlier mentioned asset and interest cover.

The debt to equity ratio is a good indicator to see how much more equity/ordinary shareholders can absorb the debt.

A low debt to equity ratio means that there are plenty of equity participants at the bank of the above quece to absorb any risks and therefore gives banks comfort whilst

A high debt to equity ratio means that the bank’s loan will be more exposed in the event of liquidation

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