September 2, 2017

  • Debt/Equity Ratio is a debt ratio used to measure a company’s financial leverage.

  • Debt to Equity = Long-Term Debt/Shareholders’ Equity

  • A lower debt to equity ratio usually implies a more financially stable business.
  • For example, suppose a company has a total shareholder value of ₹300,000 and has ₹600,000 in liabilities. Its debt/equity ratio is then 2.00 (₹600,000 / ₹300,000), or 200%, indicating that the company has been heavily taking on debt and thus has high risk. Conversely, if it has a shareholder value of ₹600,000 and ₹300,000 in liabilities, the company’s D/E ratio is 0.5 (₹300,000 / ₹600,000), or 50.00%, indicating that the company has taken on relatively little debt and thus has low risk.

  • If a company is using lot of debt is used to finance increased operations (high debt to equity), the company could potentially generate more earnings than it would have without this outside financing.
  • It isn’t generally bad, If this were to increase earnings by a greater amount than the debt cost (interest), then the shareholders benefit.
  • However, if the cost of this debt financing ends up outweighing the returns that the company generates on the debt through investment and business activities, stakeholders’ share values may take a hit. If the cost of debt becomes too much for the company to handle, it can even lead to bankruptcy, which would leave shareholders with nothing.

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