Debt to Equity Ratio - Meaning, Assumptions and Interpretation
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.
- Different Users of Ratio Analysis
- Limitations of Ratio Analysis
- Capital Structure Ratio
- Debt Ratio
- Equity to Fixed Assets Ratio
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