Debt to Equity Ratio in Capital Management by Companies

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How companies finance their businesses

Different companies have 2 ways of financing their businesses. They use

1) Equity

2) Debt

Many combinations of capital structure are also used and then if the debt is larger than the capital and equity, the companies face financial losses. Different ways have been identified to measure one company’s financial leverage, and the status of its financial health. Financial advisors and gurus have identified formulae to see how one company can work well in financial caliber. The most important of all ratios D/E, or the debt to equity ratio is explained as follows:

Debt/equity ratio

The debt to equity ratio defines the capital structure based on the combination of debt and equity. Its ratio is defined by the formula:

D/E = Total liabilities/ shareholder’s equity

Sometimes, only long-term debts are used in place of the total liabilities. It depends on the circumstances faced by companies. A person to his personal financial issues can also apply this. It is that is why known as personal ratio for debt to equity as well.

Values for D/E

If this ration is higher, this means that the company is growing on the basis of financing its business through debts. High earnings can be maintained from the relatively higher interest rate. If a company through debts starts new operations, it can increase its business and earn more rapidly as well. The industry in which companies work, also matter while the debt to equity ratio is concerned. Capital-intensive industries like auto industry, FMCG etc need a ratio value of above 2, means that they can grow with an advantage in earnings if the ratio has this value. Other than that, personal computers and small industries tend to have a value of D/E lower than 0.5 to be successful.

To know more on this subject, many other financial ratios can define how companies can work to success in the finance field and they all utilize this knowledge through financial experts to upgrade their financial health every year.