Debt/Equity Ratio

Topics: Debt, Balance sheet, Finance Pages: 3 (875 words) Published: November 27, 2012
Debt/Equity Ratio

What Does Debt/Equity Ratio Mean?
A measure of a company's financial leverage calculated by dividing its total liabilities by its stockholders' equity; it indicates what proportion of equity and debt the company is using to finance its assets. 'Debt/Equity Ratio'

A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense.

If a lot of debt is used to finance increased operations (high debt to equity), the company could potentially generate more earnings than it would have without this outside financing. If this were to increase earnings by a greater amount than the debt cost (interest), then the shareholders benefit as more earnings are being spread among the same amount of shareholders. However, the cost of this debt financing may outweigh the return that the company generates on the debt through investment and business activities and become too much for the company to handle. This can lead to bankruptcy, which would leave shareholders with nothing.

The debt/equity ratio also depends on the industry in which the company operates. For example, capital-intensive industries such as auto manufacturing tend to have a debt/equity ratio above 2, while personal computer companies have a debt/equity of under 0.5.

Read more: The debt to equity ratio is a financial metric used to assess a company's capital structure, or "capital stack." Specifically, the ratio measures the relative proportions of the firm's assets that are funded by debt or equity. The debt to equity ratio (also called the risk ratio or leverage ratio) provides a quick tool to financial analysts and prospective investors for determining the amount of financial leverage a company is using, and thus its...
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