Debt Equity Ratio

by Investing School on January 18, 2010

Debt Equity Ratio is also referred to as Debt-to-Equity ratio. In financial terms it is a financial ratio that indicates the proportion between equity and debt that is used to finance a company’s assets. This ratio is determined by calculating the company’s total liabilities and dividing into the shareholder’s equity.

This ratio can also be referred to as Risk, Gearing, or Leverage. You are able to find these figures on a company’s balance sheet or financial statement. The ratio can also be determined by using the company’s market value (also known as “book value”) for both figures. It can also be determined by using a combination of book value for debt and market value for equity.

If a company has a high debt equity ratio it means that the company has worked aggressively to finance its growth with debt. This can mean that earnings will be volatile because of the added interest expense. This high ratio is a bit risky because if the debt financing outweighs the cost earnings of the company through investment and business activities then the shareholders will not receive any money. This can eventually lead to bankruptcy.

Debt equity ratio can vary from industry to industry. For instance, if you are working in finance in the capital-intensive industries, then you may have a debt/equity ratio above 2. These would refer to auto manufacturing or industries similar to this. But, if you are in the personal computer business then your debt/equity ratio would be under 0.5.

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