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Debt To Equity Ratio

The document discusses two financial ratios: 1) Debt/Equity Ratio - A measure of a company's financial leverage calculated by dividing its total liabilities by its stockholders' equity. It indicates the proportion of funding from equity vs. debt. A high ratio means more aggressive use of debt financing which can increase earnings but also results in more interest expense and bankruptcy risk. 2) Gearing Ratio - A ratio comparing owner's equity to borrowed funds, demonstrating the degree to which a company relies on creditors vs. owners for funding. Higher gearing means more leverage and vulnerability during downturns since debt obligations must still be paid.

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Vajindra Wijewickrama
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191 views1 page

Debt To Equity Ratio

The document discusses two financial ratios: 1) Debt/Equity Ratio - A measure of a company's financial leverage calculated by dividing its total liabilities by its stockholders' equity. It indicates the proportion of funding from equity vs. debt. A high ratio means more aggressive use of debt financing which can increase earnings but also results in more interest expense and bankruptcy risk. 2) Gearing Ratio - A ratio comparing owner's equity to borrowed funds, demonstrating the degree to which a company relies on creditors vs. owners for funding. Higher gearing means more leverage and vulnerability during downturns since debt obligations must still be paid.

Uploaded by

Vajindra Wijewickrama
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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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. Note: Sometimes only interest-bearing, long-term debt is used instead of total liabilities in the calculation. Investopedia explains 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 generate more earnings than it would have without outside financing. If this increases earnings by a greater amount than the debt cost (interest), the shareholders benefit as more earnings are being spread among the same amount of shareholders. However, when the cost of the debt financing outweighs the return that the company generates on the debt, this could spell trouble for the company, leading to possible 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 automobiles tend to have a debt/equity ratio above 2, whereas personal computer companies have a debt/equity ratio under 0.5

Gearing Ratio
What Does Gearing Ratio Mean? A term describing a financial ratio that compares some form of owner's equity (or capital) to borrowed funds. Gearing is a measure of financial leverage, demonstrating the degree to which a firm's activities are funded by owner's funds versus creditor's funds. Investopedia explains Gearing Ratio The more leverage a company has, the riskier that company may be. As with most ratios, the acceptable level of leverage is determined by comparing ratios of like companies in the same industry. The best examples of gearing ratios include the debt-to-equity ratio (total debt/total equity), times interest earned (EBIT/total interest), equity ratio (equity/assets), and debt ratio (total debt /total assets). A company with high gearing (high leverage) is more vulnerable to downturns in the business cycle because it must continue to service its debt regardless of how bad sales are. A larger proportion of equity provides a cushion and is seen as a measure of financial strength

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