Debt-To-Equity [D/E] ratio
The debt-to-equity ratio, also known as the “risk ratio” or “gearing ratio,” is a leverage ratio that determines how much of the total amount of debt and liabilities should be matched by the total amount of investors’ equity. The debt-to-equity ratio uses total equity as the denominator.
What Is A Good Debt-to-equity Ratio?
The company’s growth stage and the industry in which it operates will determine what a healthy debt to equity ratio is. In many cases, a new or growing company would be expected to have a higher P/E ratio than an established or older company. However, companies in capital-intensive sectors such as mining or aerospace also have higher debt-to-equity ratios. P/E ratios below 1.0 can be considered generally healthy for an average company, while P/E ratios above 2.0 can be considered high.
The Value Of D/E Ration
The importance of the D/E ratio includes;
Investors must understand a company’s debt structure as part of financial analysis. This information provides insight into how dependent a company is on lenders and how likely it is to be able to repay any debt if it runs into trouble.
The debt-to-equity ratio explicitly states how much of the capital in a company is financed by borrowed funds and how much by its funds, e.g., equity. By doing this, it describes the capital structure of the company.
The debt-to-equity ratio also referred to as the risk ratio or debt-to-equity ratio indicates a company’s level of market-related insolvency risk.
Income of shareholders
The debt-to-equity ratio also indicates how much of the company’s profits are distributed to shareholders. Since a significant portion of profits is used to pay interest on borrowed money through fixed installments, a high debt-equity ratio leads to lower profits and dividend payments to shareholders.
In tough times, investors can use the Debt-to-equity ratio to identify highly leveraged companies that could be trouble. Investors can get a rough idea of a company’s equity structure by comparing a company’s debt-to-equity ratio to the industry average and that of other similar companies. However, a high debt-to-equity ratio is not always an indication of poor business practices. Borrowing can help a company grow, ultimately making more money for the company and its shareholders. But it’s important that every company can repay its debt, and that’s what the D/E ratio measures.