Debt-Equity Ratio

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Debt-Equity Ratio

The Debt/Equity ratio is a measure of a companyís reliance on debt, otherwise known as its financial leverage. It is used as and indicator as to what proportion of equity and debt the company is using to fund its assets and is therefore calculated by:

Total Liabilities / Equity

Depending on the company they may not use every liability and stick only to long term loans that have a lot of added interest.

If a company has a high debt to equity ratio it simply means that they used a lot of outside financing (such as business loans) to finance their company, meaning a lot of the businessís expenses go towards repaying these loans.

A business that somehow got funding elsewhere and is relatively free of debt, will have a low debt to equity ratio and will therefore be able to utilize more of its revenue. However if a lot of debt was used to finance increased operations and output then the company could potentially make more revenue than it would have without this outside financing, meaning a middle line has to be found between using outside financing and getting in to debt, of finding funding gradually.

Debt to equity is very industry specific; and it also really depends on the company at hand and the way they chose about doing things. It must be noted that neither a company with a high debt to equity ratio or a company will a low ratio is necessarily better than each other; it all depends on how they operate.

Preferred stock can be classed as component of debt or equity, but the particulars of the preferred stock need to be taken in to account.



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