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debt to equity ratio

As an investor, you must evaluate the company before making a decision on whether to invest in it or not. This evaluation would help you take trades with most potential for profit and least probability of risk. Such evaluation is carried out through Fundamental Analysis. Fundamental Analysis involves evaluating the companyu2019s financial status by studying its Balance Sheet, Income Statement (also called Profit and Loss Statement), Cash Flow Statement, and its Financial Ratios. Out of these, Financial Ratios help us compare two or more financial parameters of the company to understand its financi

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debt to equity ratio

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  1. Introduction As an investor, you must evaluate the company before making a decision on whether to invest in it or not. This evaluation would help you take trades with most potential for profit and least probability of risk. Such evaluation is carried out through Fundamental Analysis. Fundamental Analysis involves evaluating the company’s financial status by studying its Balance Sheet, Income Statement (also called Profit and Loss Statement), Cash Flow Statement, and its Financial Ratios. Out of these, Financial Ratios help us compare two or more financial parameters of the company to understand its financial status better. Using these ratios, you can understand the company’s financial health and also compare the company to its peers that operate in the same industry or sector. One such parameter is Debt to Equity Ratio.Inthisblog,wewillfindoutmoreaboutDebttoEquityRatioandthedebttoequityratioformula.

  2. DebtandEquity Inordertounderstandthisratio, we firstneedtounderstandthedefinitionofeachterm.Everycompanyraisescapital intwoways,namely,DebtfinancingandEquityFinancing. DebtFinancingisessentiallyborrowingmoneyfromacreditorbytakingaloanatafixedinterestrate.Equityfinancing refers to issuing of equity shares of the company to the general public (through IPOs and FPOs). Equity financing is moreexpensive,dilutesearningspershareofexistingshareholders,andisatimeconsumingprocess. Debt financing involves only interest payments as the primary cost. This can be deducted from their overall tax liabilityandthusmakesitthepreferredformoffinancing.However,DebtfinancingcomeswithCreditRisk.Inthe scenario where the borrower fails to repay the principal or interest amount, investors (creditors) are left with no choicebuttodeclareitasanon-performingasset.

  3. DebttoEquityRatioFormulaandHowto InterpretIt Now,letusunderstandwhatisDebttoEquityRatioandhowitiscalculated. Asthenamesuggests,thisfinancialratiocalculatesthecompany’stotaldebtversustheequity.Calculatingandevaluating the Debt to Equity Ratio tells investors how much of the company’s assets are debt financed. This would aid them in measuringcreditriskincasethecompanyisliquidated. DebttoEquityRatioisalsoknownasGearingRatioorRiskRatio.ItcomesunderLeverageRatiosorSolvencyRatios.These ratios help analysts compare the debt level of a company to its equity and assets. This allows them to understand the company’sabilitytomeetitslongtermdebtobligations. DebttoEquityratioiscalculatedbydividingtotalliabilitiesofthecompanybyitsshareholders’equity.

  4. formulaofcalculatingDebt toEquityRatio

  5. Where,TotalLiabilitiesreferstolong-termdebtwithaminimummaturityperiodofmorethanfiveyears.Itisanon-currentliability andisnotthesameasshort-termdebtwhichmustberepaidwithinfiveyears. QuickRatioorCurrentRatiowouldbebettersuitedtounderstandthecompany’sabilitytorepayitsshort-termdebtsorliabilities. AsDebttoEquityRatiocalculateswhetherthecompanycanrepayitslong-termdebt,wecandeducethatahighvalueforthisratio wouldnotbeafavourablesign.Ahighdebttoequityratiowouldsignifythatthecompanydoesnothaveenoughequitytorepayits debtsandthusmakesitahigh-riskinvestment.Thisisbecauseifacompanygoesbankrupt,onliquidation,itisfirstobligatedtopay offitsdebtliabilitiesbeforeitcanpaybackanyinvestmentsmadebyequityshareholders. AcompanywithaDebttoEquityRatioof1:1isconsideredtobesaferasthecompanyhasequalamountofdebtandequity.Whereas, acompanywithadebttoequityratioof2ormoreisconsideredtobeariskyinvestmentsincethecompanyowestwicetheamountof debtascomparedtoitsequity

  6. IdealDebttoEquityRatio Ahighdebttoequityratioindicatesseveralfactorsaboutthecompany.Weshalldiscusstheminthissegment. ReductioninEquityOwnership:Ahighdebttoequityratiosignifiesthatshareholders’equityislessandthustheyhavelowerclaimonthecompany’s earningsandassetsascomparedtothelendersandcreditors.Thisalsomeansthatalargeportionoftheearningsisusedfordebtservicing,reducingthe earningspersharefortheshareholders. IncreaseinCreditRisk:Asmentionedabove,debtfinancingcomeswithcreditrisk.Whenthedebtequityratioishigh,thecompanyhastospendmore moneytomakerepaymentsofdebtandthismightleadtothecompanydeclaringbankruptcy.Inthisscenario,equityshareholdersmaylosetheirentire investment.Themoneyfromliquidatingthecompanyanditsassetswillbeutilizedinrepayingitsliabilities. Difficultyinsecuringadditionaldebt:Incaseacompanywantstoexpanditsexistingbusinessorstartanewproject,itwilltrytoseekfundsfromlenders. Ifitalreadyhasahighdebttoequityratio,lendersmayhesitatetoprovidethecompanywithmorefundsastherewillbeariskofthecompanydefaulting itsloanrepayment.

  7. LimitationsofDebttoEquityRatio Themostcommonmistakemadebyinvestorswhenconsideringthedebttoequityratioofthecompanyisnotcheckingthe industrystandard.Asdifferentindustrieshavedifferentcapitalrequirementsanddifferenttimeframesforgrowth,adebt to equity ratio levels for each industry are different. To rectify this error, we must compare the ratio with the level for the restofthecompaniesoperatinginthesameindustry. Furthermore,whileDebttoEquityRatioisagoodparametertoassessthefinancialhealthofthecompany,wemustalso remembertocheckotherfinancialratiosofthecompanybeforemakingourinvestmentdecisions.Attheveryleast,an investormustcheckwhetherthecompanyhasagoodreturnonequitybeforeinvesting. WehopethisbloghasclarifiedDebttoEquityRatioandhowtointerpretit.

  8. CONTACTUS 8800940023 info@kundkundtc.com https://kundkundtc.com/ FF,H-166,Sector-63,Noida 201301,UttarPradesh,India

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