A company's debt, liabilities and risk are very important factors in understanding the company. Having an understanding of a company's debt and liabilities is a key component in understanding the risk of a company, thus aiding in the decision to invest, not to invest, or to stay invested in a company. There are many metrics involved in understanding the debt of a company, but for this article, I will look at Total S.A.'s (NYSE:TOT) total debt, total liabilities, debt ratios and WACC.

Through the above-mentioned four main metrics, we will understand more about the company's debt, liabilities and risk. If this summary is compared with other companies in the same sector, you will be able see which has the most debt and the most risk.

All material is sourced from Google Finance, Morningstar and the company webpage.

*1. Total Debt = Long-Term Debt + Short-Term Debt*

Debt is an amount of money borrowed by one party from another, and must be paid back. Total debt is the sum of long-term debt, which is debt that is due in one year or more, and short-term debt, which is any debt that is due within one year.

- 2007 - $14.858 billion + $4.607 billion = $19.465 billion
- 2008 - $16.191 billion + $7.722 million = $23.913 billion
- 2009 - $19.437 billion + $6.994 billion = $26.431 billion
- 2010 - $20.783 billion + $9.653 million = $30.436 billion
- 2011 - $22.557 billion + $9.675 billion = $32.232 billion

Total S.A.'s total debt has been increasing over the past five years. In 2007, Total reported a total debt of $19.465 billion. In 2011, the company reported a total debt of $32.232 billion. Over the past 5 years Total S.A.'s total debt has increased by 65.69%.

*2. Total Liabilities*

Liabilities are a company's legal debts or obligations that arise during the course of business operations, so debts are one type of liability, but not all liabilities. Total liabilities is the combination of long-term liabilities, which are the liabilities that are due in one year or more, and short-term or current liabilities, which are any liabilities due within one year.

- 2007 - $68.601 billion
- 2008 - $69.318 billion
- 2009 - $75.201 billion
- 2010 - $83.304 billion
- 2011 - $96.012 billion

Total S.A.'s liabilities have increased from $68.601 billion in 2007 to $96.012 billion in 2011, an increase of 39.95%.

In analyzing Total S.A.'s total debt and liabilities, we can see that the company currently has a large amount of debt at $32.232 billion and a very large amount of liabilities at $96.012 billion. Over the past five years, the total debt has increased by 65.69%, while total liabilities have increased by 39.95%. As the company has a large amount of debt and a very large amount of liabilities, the next step will reveal if the company has the ability to pay for their them.

## Debt Ratios

*3. Total Debt to Total Assets Ratio = Total Debt / Total Assets*

This is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. It is calculated by adding short-term and long-term debt and then dividing by the company's total assets.

A debt ratio of greater than 1 indicates that a company has more total debt than assets; meanwhile, a debt ratio of less than 1 indicates that a company has more assets than total debt. Used along with other measures of financial health, the total- debt-to-total-assets ratio can help investors determine a company's level of risk.

- 2009 - $26.431 billion / $127.753 billion = 0.21
- 2010 - $30.436 billion / $143.718 billion = 0.21
- 2011 - $32.232 billion / $164.049 billion = 0.20

As Total S.A.'s total-debt-to-total-assets ratio has been relatively the same and is below 1, this states that Total's total debt and assets have been increasing at the same rate. As the number is currently below 1 this states that the risk to the company regarding its debt to assets has been relatively the same over the past three years.

*4. Debt ratio = Total Liabilities / Total Assets*

Total liabilities divided by total assets. The debt ratio shows the proportion of a company's assets that is financed through debt. If the ratio is less than 0.5, most of the company's assets are financed through equity. If the ratio is greater than 0.5, most of the company's assets are financed through debt. Companies with high debt/asset ratios are said to be "highly leveraged." A company with a high debt ratio or that is "highly leveraged" could be in danger if creditors start to demand repayment of debt.

- 2009 - $75.201 billion / $127.753 billion = 0.59
- 2010 - $83.304 billion / $143.718 billion = 0.58
- 2011 - $96.012 billion / $164.049 billion = 0.59

In looking at Total's total liabilities to total assets ratio, we can see that the ratio has remained relatively the same over the past three years. As these numbers are above the 0.50 mark, this indicates that Total has financed most of the company's assets through debt. As Total's debt ratio is currently below 1, this implies that the company currently is not in danger of becoming insolvent and/or going bankrupt.

*5. Debt to Equity Ratio = Total Liabilities / Shareholders' Equity*

The debt-to-equity ratio is another leverage ratio that compares a company's total liabilities with its total shareholders' equity. This is a measurement of how much suppliers, lenders, creditors and obligators have committed to the company versus what the shareholders have committed.

A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in the company reporting volatile earnings. In general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations, and therefore is considered a riskier investment.

- 2009 - $75.201 billion / $52.552 billion = 1.43
- 2010 - $83.304 billion / $60.414 billion = 1.39
- 2011 - $96.012 billion / $68.037 billion = 1.41

Over the past three years, Total S.A.'s debt-to-equity ratio has been relatively the same. The debt-to-equity ratio has ranged from 1.43 in 2009 to 1.39 in 2010. As the ratio is above 1, this indicates that suppliers, lenders, creditors and obligators have more equity invested than shareholders. 1.41 indicates a moderately high amount of risk for the company. As the ratio is above 1 and considered moderately high, so is the risk for the company.

*6. Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity*

(LT Debt = Long-Term Debt)

The capitalization ratio tells the investors about the extent to which the company is using its equity to support its operations and growth. This ratio helps in the assessment of risk. Companies with a high capitalization ratio are considered to be risky because they are at a risk of insolvency if they fail to repay their debt on time. Companies with a high capitalization ratio may also find it difficult to get more loans in the future.

- 2009 - $19.437 billion / $71.989 billion = 0.27
- 2010 - $20.783 billion / $81.197 billion = 0.26
- 2011 - $22.557 billion / $90.594 billion = 0.25

Over the past three years, Total's capitalization ratio has decreased from 0.27 to 0.25. This implies that the company has had more equity compared with its long-term debt. As this is the case, the company has had more equity to support its operations and add growth through its equity. As the ratio has been decreasing so has the company's risk.

*7. Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt*

This coverage ratio compares a company's operating cash flow with its total debt. This ratio provides an indication of a company's ability to cover total debt with its yearly cash flow from operations. The higher the percentage ratio, the better the company's ability to carry its total debt. The larger the ratio, the better a company can weather rough economic conditions.

- 2009 - $12.360 billion / $26.431 billion = 0.47
- 2010 - $18.493 billion / $30.436 billion = 0.61
- 2011 - $19.536 billion / $32.232 billion = 0.61

Over the past three years, the cash flow to total debt ratio has increased from 0.47 to 0.61. The increase is very positive, but as the ratio is still below 1, this implies that the company does not have the ability to cover its total debt with its yearly cash flow from operations.

Based on the above five debt ratios listed above, we can see that Total S.A. ratios have remained even or improved slightly. As this is the case, the ratios indicate a slight decrease in the company's risk compared to 3 years ago. The next step will reveal how much the company will pay for the debt incurred.

## Cost of Debt

The cost of debt is the effective rate that a company pays on its total debt.

As a company acquires debt through various bonds, loans and other forms of debt, the cost of debt metric is useful, because it gives an idea as to the overall rate being paid by the company to use debt financing.

This measure is also useful because it gives investors an idea as to the riskiness of the company compared with others. The higher the cost of debt the higher the risk.

*8. Cost of debt (before tax) = Corporate Bond rate of company's bond rating.*

- S&P rated Total S.A. bonds "AA-"
- Current 20-year corporate bond Rate of "AA" = 3.62%
- Current cost of Debt as of October 7th 2012 = 3.62%

According to the S&P rating guide, the "AA" rating is - "Very strong capacity to meet financial commitments." GE has a rating that meets this description.

*9. Current tax rate ( Income Tax total / Income before Tax)*

- 2007 - $13.559 billion / $25.335 billion = 53.52%
- 2008 - $14.146 billion / $25.099 billion = 56.36%
- 2009 - $7.751 billion / $16.380 billion = 47.31%
- 2010 - $10.228 billion / $21.035 billion = 48.62%
- 2011 - $14.073 billion / $26.654 billion = 52.80%

5-year average subtracting 2009 = 51.72%

Over the past five years, Total S.A. has averaged a tax rate of 51.72%.

*10. Cost of Debt (After Tax) = (Cost of debt before tax) (1 - tax rate)*

The effective rate that a company pays on its current debt after tax.

- .0362 x (1 - .5172) = Cost of debt after tax

The cost of debt after tax for Total S.A. is *1.75%*

**Cost of equity or R equity =** Risk free rate + Beta equity (Average market return - Risk free rate)

The cost of equity is the return a firm theoretically pays to its equity investors, for example, shareholders, to compensate for the risk they undertake by investing in their company.

- Risk free rate = U.S. 10-year bond = 1.74% (Bloomberg)
- Average market return 1950 - 2011 = 7%
- Beta = (Google Finance) Total S.A.'s beta = 1.02

Risk free rate + Beta equity (Average market return - Risk free rate)

- 1.74 + 1.02 (7-1.74)
- 1.74 + 1.02 x 5.26
- 1.74 + 5.37 = 7.11%

Total S.A. has a cost of equity or R Equity of 7.11%, so investors should expect to get a return of 7.11% per-year average over the long term on their investment to compensate for the risk they undertake by investing in this company.

(*Please note that this is the CAPM approach to finding the cost of equity. Inherently, there are some flaws with this approach and that the numbers are very "general." This approach is based off of the S&P average return from 1950 - 2011 at 7%, the U.S. 10-year bond for the risk free rate which is susceptible to daily change and Google finance beta.*)

## Weighted Average Cost of Capital or WACC

The WACC calculation is a calculation of a company's cost of capital in which each category of capital is equally weighted. All capital sources such as common stock, preferred stock, bonds and all other long-term debt are included in this calculation.

As the WACC of a firm increases, and the beta and rate of return on equity increases, this states a decrease in valuation and a higher risk.

By taking the weighted average, we can see how much interest the company has to pay for every dollar it finances.

For this calculation, you will need to know the following listed below:

Tax Rate = 51.72% (Total S.A.'s five-year average Tax Rate)

Cost of Debt (before tax) or **R debt** = 3.62%

Cost of Equity or **R equity** = 7.11%

Debt (Total Liabilities) for 2011 or **D** = $96.012 billion

Stock Price = $50.27 (October 8th, 2012)

Outstanding Shares = 2.26 billion

Equity = Stock price x Outstanding Shares or **E** = $113.610 billion

Debt + Equity or **D+E** = $209.622 billion

**WACC** = R = (1 - Tax Rate) x R debt (D/D+E) + R equity (E/D+E)

(1 - Tax Rate) x R debt (D/D+E) + R equity (E/D+E)

(1 - .5172) x .0362 x ($96.012/$209.622) + .0711 ($113.610/$209.622)

.4828 x .0362 x .4580 + .0711 x .5420

.0080 + .0385

= 4.65%

Based on the calculations above, we can conclude that Total S.A. pays 4.65% on every dollar that it finances, or 4.65 cents on every dollar. From this calculation, we understand that on every dollar the company spends on an investment, the company must make $.0465 plus the cost of the investment for the investment to be feasible for the company.

## Summary

In analyzing Total S.A.'s total debt and liabilities, we can see that the company currently has a large amount of debt at $32.232 billion and a very large amount of liabilities at $96.012 billion. Over the past five years, the total debt has increased by 65.69%, while total liabilities have increased by 39.95%.

Based on the above five debt ratios listed above, we can see that Total S.A. ratios have remained even or improved slightly over the past 3 years. As this is the case, the ratios indicate a slight decrease in the company's risk compared to 3 years ago. Based on the slight improvement indicated from the ratios above, this states that currently Total S.A. currently has the ability to pay for its debts.

As Total S.A.'s bond rating currently stands at "AA-" this indicates that the company has a "Very strong capacity to meet financial commitments."

The CAPM approach for cost of equity states that shareholders need 7.11% average per year over a long period of time on their equity to make it worthwhile to invest in the company. This calculation is so based on the average market return between 1950 and 2011 at 7%.

The WACC calculation reveals that the company pays 4.65% on every dollar that it finances. As the current WACC of Total S.A. is currently 4.65% and the beta is above average at 1.02, this implies that the company needs at least 4.65% on future investments and will have average volatility moving forward.

Based on the calculations above, the company has a large amount of debt and a large amount liabilities, but currently has the capacity to make its debt payments and meet its tax obligations.

The analysis of Total S.A.'s debt and liabilities indicates a company with a large amount of debt and a very large amount of liabilities. The analysis also reveals the company is showing some improvement regarding the debt ratios. The Bond rating of "AA-" by S&P indicates that a company has a "Very strong capacity to meet financial commitments." The WACC reveals that Total S.A. has the ability to add future investments and assets at low rates. Currently, Total S.A. has the ability to pay for its debts and improve its debt ratios thus slightly lowering its risk to shareholders.

For another article on Total S.A. please read:

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