10. Debt to Equity Ratio (D/E)
Debt/Equity Ratio = Total Liabilities / Shareholders’ Equity
This is one the key ratio’s that help in analysing the capital structure of the company. Debt/Equity (D/E) Ratio, calculated by dividing a company’s total liabilities by its stockholders’ equity, is a debt ratio used to measure a company’s financial leverage. The D/E ratio indicates how much debt a company is using to finance its assets relative to the value of shareholders’ equity. The formula for calculating D/E ratios is:
Assume a company has INR 100,000 of bank lines of credit and a INR 500,000 mortgage on its property. The shareholders of the company have invested INR 12,00,000 (1.2 million) . Here is how you calculate the debt to equity ratio.
1,00,000 + 5,00,000
—————————————– = 0.5 or 50%
How to Analyse:
The debt to equity ratio is a financial, liquidity ratio that compares a company’s total debt (what it owes) to total equity. The debt to equity ratio shows the percentage of company financing that comes from creditors and investors. A higher debt to equity ratio indicates that more creditor financing (bank loans) is used than investor financing (shareholders). A high debt/equity ratio also means that a company has been aggressive in financing its growth with debt. Mind you – aggressive leveraging practices are often associated with high levels of risk. This may result in volatile earnings as a result of the additional interest expense. It’s best to look at historical debt/equity values of the company & then get analytical over the trend. This will give you the right picture of its financial structure.