Sum of the Parts Valuation
Equity valuation is usually conducted for an entire enterprise. For instance, if we are trying to come up with a valuation for Apple Inc, we will usually consider Apple Inc as being one single indivisible unit. This is because the cash flows that will accrue to Apple Inc are intertwined and all of the cash […]
Financial Goal – Profit vs Wealth
Every firm has a predefined goal or an objective. Therefore the most important goal of a financial manager is to increase the owner’s economic welfare. Here economics welfare may refer to maximization of profit or maximization of shareholders wealth. Therefore Shareholders wealth maximization (SWM) plays a very crucial role as far as financial goals of […]
Money Market Futures – Meaning and Types
The money market is a full-fledged financial market. Hence, there are many investors who are keen to hedge the risks which emanate from the money market. The need to hedge these risks has led to the creation of several money market derivatives. There are certain exchange-traded derivatives that are a part of the money market […]
Tulip Mania of the 17th Century
Asset bubbles have always been a testimony to the bizarre things that humans can accomplish when they abandon their own rational thinking and a herd mentality sets in. However, the case in point of the first asset bubble in recorded history i.e. the tulip mania brings this to light. The sheer absurdity of the situation […]
Accounting for Player Contracts – Advanced Scenarios
In the previous article, we have already seen that accounting for sporting franchises involves certain scenarios that are specific only to the sporting industry. We saw how the accounting for player contracts was unique and why it was important to understand the accounting implications. In this article, we will continue to have a look at […]
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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