What Is Debt Equity Ratio?
There are different types of ratios like financial liquidity ratios, Debt equity ratio etc..The debt equity ratio is the ratio calculated by dividing company’s total liabilities by its shareholders equity. This ratio is calculated on the basis of the numbers of balance sheet at the end of the financial year. By this ratio company can evaluate the leverage available to it. The other name by which the debt equity ratio is known is risk or gearing ratio.
The Formula By Which The Debt Equity Ratio Is Calculated Is As Follows:
Debt/Equity ratio= Total Liabilities/ Total Shareholder’s equity.
Total shareholder’s equity can be derived by reducing the amount of the other liabilities from the amount of total assets. The debt equity ratio will be more helpful when there will be some of the ambiguity in the accounts in the balance sheet of an enterprise so that the different stocks can be compared by this. The debt ratio will give you easy as well as comparable format so that you can have the decisions based on it. FinanceShed’s analysis of the debt equity ratio formula.
Use Of Debt Equity Ratio:
It is known that the debt equity ratio is generally used for the measurement of company’s debt relative to the value of its net assets. It is also said that it shows that how much company is taking debt on the leverage of asset. The risk can be also analyzed by the result of this ratio. The higher the debt equity ratio there will be more risk and it will mean as if company have the forward steps towards the growth with debts.
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The higher ratio shows that the company is having the debts to generate the profits which it will never be able to make if the debt would not have been taken by the company. This high debt can work in both the ways for the company as on the one side if the returns from this debt will be more than the interest paid, then the profits will be more and the shareholders will be interested to be in the company as you have given more returns.
On the other side if there will be fewer amounts of advantages occurring from the debt and the interest to be paid, then the share price will decline and thus there will be a kind of loss to the company.
Limitations Of Debt Equity Ratio:
It is very important that when the ratio is calculated the industry of the company is taken into consideration as the different industries will be in need of the different amount of capital as per their work. So it will be necessary to determine industry and also you cannot have the decision based on the ratio as the high ratio may be common in one business and not in the other.
The things to be included in the ratio are also needed to be seen after as it will be different in the eyes of all the experts and analyst so that you cannot have the accurate result each and every time you have the ratio analysis.