Exchange Traded Derivatives
Now since we have a basic idea regarding what derivatives really are and the function that they perform, it time to get into a little more detail. At this point, it is essential to introduce the concept of exchange traded derivatives and over the counter derivatives. We have briefly brushed on them in the previous […]
Strategic Capital Budgeting
The capital budgeting process is at the heart of the financial decision-making which takes place in any organization. However, up until now, the capital budgeting decision has been considered to be a financial decision. As a result, the evaluation of projects and the capital allocation process are based on discounted cash flow analysis. Many organizations […]
The Wells Fargo Auto Insurance Scandal
Wells Fargo is one of the largest banks in the United States. However, of late, it has also become one of the most infamous banks. A couple of years back Wells Fargo was in the news since its sales executives opened up fake accounts without the knowledge of the customers simply to meet the sales […]
Dollar-Cost Averaging
There are two predominant schools of thought about the stock market. The views of these schools of thought are somewhat contradictory. There is one school of thought which advises investors to stay away from stock market investments since they are inherently volatile. You will often see people who believe in this school of thought advocating […]
History of Derivatives
Derivatives may have found their way into the media in very recent times. However, they have been used by mankind for a very long time. Since the inception of time, humans have not liked the idea of uncertainty. More so, they did not like the idea of economic uncertainty. Hence, the need to offset this […]
The debt to equity ratio is the most important of all capital adequacy ratios. It is seen by investors and analysts worldwide as the true measure of riskiness of the firm. This ratio is often quoted in the financials of the company as well as in discussions pertaining to the financial health of the company in TV shows newspapers etc.
Debt to Equity Ratio = Total Debt / Total Equity
The total equity includes retained earnings which have been listed on the balance sheet
There is subjectivity with regards to treatment of preference shares. Some companies add them to debt while others add them to equity based on the relative features of the preference shares issued. However, usually the quantum of preference shares in not big enough to make a difference.
The debt to equity ratio tells the shareholders as well as debt holders the relative amounts they are contributing to the capital. It needs to be understood that it is a part to part comparison and not a part to whole comparison.
The debt to equity ratio measures the amount of debt based on the figures stated in the balance sheet. Of late there have been many ways figured out to take on debt without it showing up on the balance sheet.
The debt to equity ratio is a very old measure and is not meant to take into account such complication. Some analysts factor in off balance sheet debt as well to get a better picture. However, they do not have enough information to be very accurate at this endeavor.
Debt to equity ratio provides two very important pieces of information to the analysts. They have been listed below.
Shareholders as well as debt holders want to know what the maximum downside is and debt to equity ratio helps them understand what they would end up with if the company were to stop functioning as a going concern.
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