What is the debt to equity ratio
Through debt to equity ratio, we get to know how much percentage of total assets of a company is financed from debt and how much percentage is financed from shareholders equity.
The debt-to-equity (D / E) ratio compares a company’s shareholder equity to its total liabilities and can be used to evaluate how much leverage a company is using.
debt to equity ratio is type of solvency ratio which is also known as debt-equity ratio
Debt to equity ratio Formula
The debt-to-equity (D / E) ratio is calculated by dividing the company’s total liabilities by its shareholder equity. These numbers are available on the balance sheet of a company’s financial statements.
It is also commonly referred to as a leverage ratio, which is a financial ratio that measures how much capital a company’s assets hold as debt, or a company’s ability to meet its financial obligations. It shows
Debt-equity ratio = Total debt / Total liabilities
Total debt or liabilities = Short-term debt + Long-term debt
If you do not know about the liabilities, assets, and equity for a company, then you can read the first post of our liquidity ratio, in which we have explained in great detail, then before reading the ratio you have to read the first post of liquidity ratio. Whose link is given below https://www.capitalcred.in/liquidity-ratios-current-assets/
Example of Debt to equity ratio
So let’s take a look at a simplified example of a company that you can consider as an investment.
We are taking the example of a BHEL, whose financial data of the company you can find in the financial section of the balance sheet on the website called Moneycontrol.com.
|Company briefs||Results in Cr. (INR)|
By using these data and the given formula, you can calculate the debt to equity ratio of the BHEL company.
Debt-equity ratio of BHEL company = (22647.41 + 9442.80) / 29181.21 = 1.099
Debt to equity ratio analysis
- When a company’s debt to equity ratio is equal to 1, it means that The total assets of the company are financed by debt as much as it is financed by equity. We need investment in the company where the equity in the company is more than the debt.
- If the debt ratio was 0.5, it indicates that the company has half the liabilities compared to equity. Simply put, the company’s assets are owned by 2: 1 investor vs creditors
- In general, the lower the liability to equity ratio, the more financially secure a company is, as most of its operations are funded by investor equity rather than debt.
- Companies with low liabilities to equity ratio are often more stable and more attractive to both creditors and investors.
- Some industries, such as finance and manufacturing, have a higher debt to equity ratio because they require a lot of capital.
- What does it mean when a company’s debt to equity ratio is negative, a debt ratio of less than zero will be cause for concern because it shows the volatility in the business and negative return on investment – typically higher interest on debt than investment return Inform of.
To derive debt-equity ratio of any company, it is important to have long-term liabilities, short-term liabilities, and total assets of the company which you find on the company’s balance sheet.
This ratio uses both short-term and long-term liabilities, so short-term liabilities cannot be cleared, so a company must pay attention while analyzing it.
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