WHAT İS DEBT TO EQUITY RATIO?
Debt to equity ratio is a ratio to measure company’s financial leverage.
The values gotten from it help analysts to identify additional profitability growth potential, assess the degree of possible risks and determine the dependence of the level of profit on external and internal factors. With the help of this ratio, it is possible to influence the net profit of the organization, managing financial liabilities, and a clear idea of the appropriateness of using credit funds.
This ratio is important for investors who view this company as an investment of their funds. They are attracted by companies with a predominance of equity. However, the share of borrowed funds should not be too low, as this will reduce the proportion of their own profits, which they will receive in the form of interest.
HOW TO CALCULATE THE DEBT TO EQUITY RATIO
Debt to Equity ratio = Long-term liabilities / Equity
The formula above is for calculating the ratio of debt to equity.
It is calculated by dividing liabilities over equity.
This ratio describes the structure of the company’s capital and characterizes its dependence on external sources of financing. It is assumed that the amount of all arrears should not exceed the amount of equity.
HOW TO INTERPRET THE RATİO OF DEBT TO EQUİTY?
After calculating this ratio, you are going to get a result. Let’s see what to expect from it and what each value means for the company.
The normal value of the coefficient should be 0.5-0.7. Coefficient 0.5 is optimal (equal ratio of own and borrowed capital). 0.6-0.7 – is considered a normal coefficient of financial dependence. Coefficient below 0.5 indicates the organization’s too cautious approach to raising borrowed capital and missed opportunities to improve the profitability of equity by using the effect of financial leverage.
If the level of this indicator exceeds the recommended number, then the firm has a high dependence on creditors, which indicates a deterioration in the stability of the financial situation. The higher the ratio, the greater the company’s risk of potential bankruptcy or a shortfall in cash.
WHAT İS RATİO OF DEBT TO EQUITY İS USED FOR?
This ratio if very important for marketing and it is used for different purposes. Let’s look at what this ratio is used for and what does it represent.
-Comparisons with the average level in the industry, as well as with the indicators of other firms. The value of the coefficient of financial leverage affects the industry, the scale of the enterprise, as well as the way of organizing production (capital-intensive or labor-intensive production). Therefore, the final results should be evaluated in dynamics and compared with the indicator of similar enterprises.
– Analysis of the possibility of using additional borrowed sources of financing, the efficiency of supply-side activities, the optimal decisions of financial managers in the choice of objects and sources of investment.
– Analysis of the structure of debt, namely: the share of short-term debts in it, as well as arrears in the payment of taxes, wages, various deductions.
– Determination by the creditors of financial independence, stability of the financial position of the organization, which plans to attract additional loans.
We hope you have enjoyed this article and now, have a better understanding of debt to equity ratio and everything about it!