What's Hot

    Banks cannot perennially rely on RBI money to support credit offtake: Das

    August 5, 2022

    Economy is an island of macroeconomic and financial stability, says RBI Governor Shaktikanta Das

    August 5, 2022

    RBI’s MPC increases policy rate by 50 bps to counter inflation

    August 5, 2022
    Facebook Twitter Instagram
    Facebook Twitter Instagram
    Invest PolicyInvest Policy
    Subscribe
    • Banking
    • Economy
    • Finance
    • Insurance
      • LIC
    • Investment
    • Market
    • Money
    • MF
    • More
      • Scheme
      • Property
    Invest PolicyInvest Policy
    Home Debt-equity ratio analysis: Why the debt-equity ratio is important?
    Finance

    Debt-equity ratio analysis: Why the debt-equity ratio is important?

    InvestPolicyBy InvestPolicyMarch 20, 2020Updated:November 26, 2021No Comments4 Mins Read
    Facebook Twitter LinkedIn Telegram Pinterest Tumblr Reddit WhatsApp Email
    Debt to Equity Ratio
    Share
    Facebook Twitter LinkedIn Pinterest Email

    The debt-equity ratio of a business refers to the contribution of capital invested by creditors, shareholders and owners in the business. It is a financial tool, used to estimate how much amount can be borrowed using shareholder contributions. A debt-equity ratio can be defined as a capital structure ratio. It is used to evaluate the financial stability of a business for long periods using sheet data. The debt-equity ratio is viewed differently by different classes such as lenders, investors, management and government when assessing the company’s position. Interpretations of financial ratios may vary according to different people.

    For example, investors and creditors use this data to make effective investment decisions. If the company has sufficient capital to meet its short-term and long-term obligations, the business is considered a solvent (solvent). Thus this data is used by creditors and investors to understand the long-term solvency of a company or business. The debt-equity ratio matters a lot. Therefore, information about this is being given through this article.

    Why the debt-equity ratio is important?

    A debt-equity ratio is a general equation that provides data about the collection of money and simply describes how the fund has been raised to run the business. It is considered an important indicator of the financial health of a business. It is mainly used to understand the company’s stability and ability to raise additional capital for growth and expansion.

    If you own a company, this ratio will be used when you want to take advantage of debt or business line of credit. Investors see the debt-equity ratio of a company as an important financial indicator, as it helps them understand the risks involved in investing in a particular company. The higher the debt-equity ratio of a company, the riskier it is to invest in.

    What debt-equity ratio is considered good?

    When the debt-equity ratio is around 1 to 1.5, it is considered good. But the ratio is not constant for every industry. It depends on the industry and varies, as some industries use credit more than other industries finance it. Some industries such as financial and manufacturing, which often require more capital, typically have higher debt-equity ratios. In these it can be more than 2. When the debt-equity ratio of the company is high, it means that the company mainly uses debt for the growth and financing of its business. In addition, companies that invest more in assets and operations also have higher debt-equity ratios. It is often seen differently by investors and lenders. The high debt-equity ratio for the lender means that the business is running through debt and will not be able to repay its debts in the future. If a company has a low debt-equity ratio, it means that the company has enough money and does not believe in operating by borrowing. In contrast, investors are more likely to invest in enterprises that have a higher debt-equity ratio. Investors often avoid investing in enterprises with low debt-equity ratios, as such a company does not realize its full potential through public lenders.

    Debt-equity ratio formula

    We already know about debt-equity ratio, let’s now try to understand its formula –

    Debt-equity ratio = total liabilities / shareholder’s equity

    The formula consists of two elements, which are –

    Total Liabilities – It shows the total loan taken by the company. These include short-term and long-term debt and other liabilities such as tax liabilities etc.

    Shareholder’s equity The result obtained by subtracting the company’s assets from total liabilities reflects shareholder’s equity.

    Profit when the debt-equity ratio is high

    A high debt-equity ratio can sometimes be good, as it indicates that the business can easily meet its debt obligations through its cash flow and is using debt to increase returns.

    Loss on high debt-equity ratio

    In cases when the company’s debt-equity ratio is very high, the company’s liabilities are high and the company may lose the ability to repay its debts. In such cases the cost of borrowing in the form of WAAC of the company becomes very high and the cost of equity also becomes higher and thus the price of the company’s shares decreases.

    Share. Facebook Twitter Pinterest LinkedIn Tumblr Telegram Email
    Previous ArticleDifference between tax free bonds and tax saving bonds
    Next Article How to become a millionaire in 10 years?
    InvestPolicy

    Related Posts

    Banks cannot perennially rely on RBI money to support credit offtake: Das

    August 5, 2022

    Economy is an island of macroeconomic and financial stability, says RBI Governor Shaktikanta Das

    August 5, 2022

    RBI’s MPC increases policy rate by 50 bps to counter inflation

    August 5, 2022
    Add A Comment

    Leave A Reply Cancel Reply

    Top Posts

    FPI withdrawal continues, shares worth Rs 31,430 crore sold so far in June

    June 19, 2022

    HCL Tech stock became Sensex’s top loser, brokerage reduced target due to weak results, gave this advice on investment

    July 13, 2022

    How to get rid of credit card debt?

    December 16, 2019
    Advertisement

    Our main motto is to help our customers in making personal finance decisions easy and convenient as per their comfort. We are committed to provide accurate and unbiased information at your doorstep and keep it transparent among our customers.

    We're social. Connect with us:

    Facebook Twitter YouTube LinkedIn
    Top Insights

    Banks cannot perennially rely on RBI money to support credit offtake: Das

    August 5, 2022

    Economy is an island of macroeconomic and financial stability, says RBI Governor Shaktikanta Das

    August 5, 2022

    RBI’s MPC increases policy rate by 50 bps to counter inflation

    August 5, 2022
    Must Read

    What is UTR Number in Phonepe and Google Pay? how to check

    March 1, 2022

    About 100 agro-product companies under CBI scanner for bank fraud

    July 31, 2022

    Is the declining rupee a crisis or an opportunity?

    August 5, 2022
    © 2022 Invest Policy.
    • About Us
    • Contact Us
    • Advertise
    • Privacy Policy

    Type above and press Enter to search. Press Esc to cancel.