Debt Equity Ratio: The debt-equity ratio is an indication of the relationship between the contribution of the creditors and shareholders /owners in the capital employed in business. It’s one of the important financial liquidity ratios that are used to assess the performance of a company. Must Check Various Types of Lease.
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Debt – Equity ratio formula
DER = Total amount of Debt/Total equity funds
It expresses the extent to which shareholder’s equity can meet a company’s obligations to creditors in the event of liquidation of its operations.
For example, if the total amount of liabilities of a company is 15 crore rupees where total equity amount is 10 crore rupees.
DER = 15/10. =1.5 times or 150%
It means for every 1.5 rupees of lenders there is only 1 rupee amount of equity funds to compensate the creditors.
Points to be considered while calculating DER :
1. It’s required to know that there are many ways to find the debt-to-equity ratio So it is important to be clear about the type of debt and equity in operation in an entity when using it to analyze the performance.
2. Sometimes amount raised through the issue of preferred shares is considered as debt rather than equity while calculating the equity ratio because this amount must be repaid to preference shareholders at the maturity of the time period mentioned previously at the time of issue. Must Read Weighted Average Cost of Capital.
Importance ofDebt – Equity ratio
- When the Debt Equity ratio of a company is very high then it’s an indication that the company’s operations are going in vain in generating enough funds to meet the fixed financial obligations ie debt.
- When the Debt Equity ratio of a company is too low that means the company is failed in getting the benefits from financial leverage.
- When comparing the Debt equity ratio of two or more companies, we should ensure that they belong to similar industries because comparison of different companies of different industries can’t depict more accurate results. For instance, labor-intensive industries require less amount of capital when compared to others. So obviously it has a greater impact on the debt-equity ratio of the companies belonging to such industry.
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