Debt to Equity Ratio
This ratio is a financial tool that represents leverage of a company. It is a factor that can give investors or banks a brief idea about the risk involved in the equities a company own. Simply this ratio gives an idea about how much debt a company has over the total asset it owns.
Formula:
Asset – Liability = Equity
Debt / Equity = Debt to Equity ratio.
Significance
A company with high D/E ratio indicates that company is having high risk of leveraging. So this parameter can be used by investors or banks before purchasing the company share or providing loan. Conversely, if the D/E ratio is small the company is having low risk, so it is safe to provide a loan or purchase company share.
For example: Rahman and Ram applied for a loan. When the bank checks their records, they found that Rahman owns a total asset worth Rs.1,00,000, but he also have some liabilities of Rs 80000. So Rahman’s equity is Rs 20000. Which means Rahman’s Debt to Equity Ratio is 4. So, Rahman have 4 INR of debt to each 1 INR of equity. So it will be very risky to give a loan to Rahman.
On other hand Ram’s asset is worth Rs.150000 with a liability of just Rs.50000 so his equity is 1,00,000 INR. So his debt to equity ratio is 0.5, which means for every .5INR of debt Ram have 1INR of equity, so there is low risk providing loan to Ram.
