What is Debt To Equity Ratio –
Debt to Equity Ratio is leverage ratio or solvency ratio. D/E is a financial ratio which measures company’s total debt relative to its shareholder’s equity. D/E is important financial metric used to calculate company’s financial leverage condition. This ratio tells us about how company is financing its operation through debt or equity (own fund). D/E can be calculate by dividing total debt or total liabilities by shareholder’s equity. Simply the ratio shows that for every rupee of equity how much debt you have. D/E ratio is very important because banks check this ratio before lending the funds to the company.
D/E ratio is the relationship between company’s total debt and shareholder’s equity. This ratio is important to understand capital structure of a company. D/E ratio can be defined as the ratio of total debt to total shareholder’s equity is known as debt to equity ratio of a company. Total debt and total shareholder’s equity is available in the balance sheet of a company.
The formula of D/E is
Debt To Equity Ratio = Total Debt / Total Shareholder’s Equity
We can study above examples,
For company A, total debt is 100 and total equity is 500, so we can calculate D/E,
D/E of company A = total debt / total equity
D/E of company A = 100 / 500
D/E of company A = 0.2
For company B, total debt is 200 and total equity is 150, so we can calculate D/E,
D/E of company B = total debt / total equity
D/E of company B = 200 / 150
D/E of company B = 1.33
From above example we have calculated D/E of company A and company B.
D/E ratio of company A is 0.2 which means for every 1 rupee of equity company has debt of 0.2 rupee. 0.2 is very low D/E ratio which is good for investments. A low D/E ratio is always good because it tells us that company is financing its operation more from equity and less from debt.
D/E ratio of company B is 1.33 which means for every 1 rupee of equity company has debt of 1.33 rupee. 1.33 seems to very high D/E as compare to 0.2 which looks bad for investments. High D/E companies are highly risky to invest depending on their industries.
Debt to Equity Ratio varies from industry to industry. Normally Manufacturing industries have high D/E ratio and Service, IT industries have low D/E ratio because of different capital needs. Investors and analysts compare company D/E ratio with industry D/E to identify low and high D/E ratio. Investors and analysts prefers low D/E ratio over high D/E ratio which seems good and safe investments. Sometimes high D/E ratio looks good because of that company makes big profits by using high debt, but it can be risky.