This debt to equity ratio calculator estimates the so called gearing ratio which represents the proportion of debt financing in a company relative to its equity, by 3 different formulas. There is more information on how to calculate these figures below the application form.
How does this debt to equity ratio calculator work?
Especially designed for accounting and financial professionals, this debt to equity ratio calculator can help in estimating the debt to equity ratio by 3 different methods as explained below:
Debt to Equity Ratio (as a proportion of total debt) = Total debt / Total equity
Debt to Equity Ratio (as a proportion of Long term debt) = Long term debt / Total equity
Debt to Equity Ratio (as a proportion of Long term debt) = Long term debt / (Total equity + Long term debt)
- Equity represents the value of the share capital and reserve, or the current value of the equity shares.
- Debt represents the value for items such as loans, redeemable preference shares, debentures, bank overdrafts or lease.
As it can be observed the value of the ratio varies depending on the formula used. For instance a debt to instance ratio of 0.5 obtained with the first formula explained above indicates that the company uses a debt-financing equal to 50% of its equity. While a ratio of 0.3 generated by the 2nd formula demonstrates that the entity uses long-term debts equal to 30% of its equity as a financing source. Finally a ratio of 0.23 estimated with the 3rd formula indicates that the long-term debts represent 23% of the company's total long term finance sources.
Why is debt to equity ratio important?
The debt to equity ratio is a relevant indicator that is strongly interpreted as a measure of the financial risk of a company which means the risk to get to default.
Considering the above, when debt-to-equity ratio registers high values it indicates that the likelihood for the company to get to default is increasing. However, this interpretation rule it not generally applicable as a higher debt-equity ratio is not always a negative signal. This is due to the fact that usually debt represents a much cheaper financing source than equity because of tax on savings. Thus, the debt to equity ratio should be analyzed in direct relation with its financial risk associated. And so when the financial risk registers an acceptable value, the strategy to borrow more at cheaper costs could help companies develop.
As it is a measure of the capital structure, the debt to equity ratio is an important financial figure that is permanently assessed by companies.
Investors and lenders analyze this ratio too as this impacts the security of their investment, thus measuring this indicator may help them decide either their desired rate of return(which is a measure of the associated risk of the investment too) or their investment plans (invest/disinvest a project instead of another).
The optimal level of the debt to equity ratio varies from one company to another by a wide range of factors, amongst them are:
The cost of the financing each company has;
The perspective of the business and its chances to develop;
The profitability of the business and how much profits and revenue can be obtained by using debt;
The opportunities the business can take advantage of by borrowing money.
Example of a calculation
Let’s take the example of a company with this status:
- Total equity = $500,000
- Total debt (short + long term) = $150,000
- Long term debt only = $100,000
■ Debt to Equity Ratio (proportion of Total debt) ): 0.30
■ Debt to Equity Ratio (proportion of Long term debt_1): 0.20
■ Debt to Equity Ratio (proportion of Long term debt_2): 0.1719 Feb, 2015 | 0 comments