Debt-Equity Ratio

The Debt-Equity ratio indicates the relative contribution of total debt and owner’s equity in the capital structure of the company; the relative contribution of each to finance the company’s assets. It is computed as:

Debt
Equity

The debt component includes all liabilities including current liabilities. The equity component consists to net worth and preference capital.

In general, the lower the debt to equity ratio, the higher the degree of protection felt by the lenders. It indicates a wider safety cushion for the lenders. A high debt to equity ratio means that the company has been aggressively using debt to finance its assets. The ratio must be compared with the industry average in which the company operates. There is no norm for any maximum or minimum debt-equity ratio. Banks and financial institutions set their own norms considering the capital intensity and other factors.

One of the limitations of this ratio is that the computation of the ratio is based on the book values of debt and equity. It is sometimes useful to calculate this ratio using the market values of debt and equity.

Example:
 Year 2009 Year 2008 Debt (including current) \$2,654,900 \$2,086,450 Shareholder's Equity \$1,769,879 \$1,567,632 Debt-Equity ratio: \$2,654,900 \$1,769,879 => 1.50

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