Debt To Equity Ratio Explained

you are welcome to, In this post, we will discuss a very important ratio  Which is the debt to equity ratio  The  Debt to equity ratio is the solvency ratio  All the investors and analysts see it very carefully  And why is that?  I will tell you the reason.  See when you invest in any company then a very important part for you is  Whether the stock rises or not, at least your principal should be protected. 

Your money should be protected.  Your money shouldn’t be zero.  Why will it become zero?  If the company gets bankrupt then the money will be zero.  So if the company is in business that means it is solvent now, we know that it is solvent by the solvency ratios.  And the most important ratio in that is the debt to equity ratio.  We will know that in this post.  How is its calculation done?  And how to interpret it?  I will show you a calculation with that. 

  So now what is this total debt?  This is your long-term debt  Plus short-term debt  We have to add both of them.  You will get the long-term debt by non-current liability  You will get the short-term debt by the current liabilities in the balance sheet.  Some analysts only take long-term debt  Whatever formula you are using  If you are taking only long-term debt to compare the companies,  use the same formula in both and if you are using a single website,  so use the same website to compare both the companies. 

But if you ask me ideally you should take both long-term debt and short-term debt.  Because we want to see the solvency position of the company.  whether there is any solvency risk or not so we should ideally take its total debt  Let’s calculate it with an example.  Let’s say the long-term debt in the company is 100 crores.  And in short term too,  In the short term, I reduce a little.  Let’s say the short term is 50 crores. 

And let’s say the equity capital of the company  We also call it shareholders funds.  Let’s say the total shareholder’s funds is 100 cr  So here our debt-equity ratio will be  We will write total equity share capital below in the denominator.  And on top, we will write Total Dept.  150 crores will come on the top.  The debt-equity ratio is 1.5  So now a 1.5 debt-equity ratio is a comfortable position?  or is it an uncomfortable position for it,

I tell you some important points about the debt-equity ratio first debt-equity ratio should always be less than one  Your ideal ratio should be less than 1.  Only then will a company be in a comfortable position.  So if the debt is less than your total equity capital  So at least the company will have money to pay and it will be in a comfortable position.  In this case, it is more than 1 hence, it is an uncomfortable position If you ask me Then suppose if the market turns bad and the company’s tough time starts.  So in such cases lower debt-equity companies  Whose debt will be less  There are more chances for that company to survive. 

Otherwise, debt is such a liability that you have to pay  If your profits are being eroded then also you have to pay interest.  Principal and interest have to be paid every month.  So debt is such a thing that can also bankrupt the company.  When you are comparing companies, keep one more thing in mind you have to compare only the company with the same sector at the debt-equity ratio.  And we talk about higher debt-equity ratio companies  For example power companies, that manufacture power plants take on more debts because generally all projects are made out of project finance.  Bank also has a lot of debt.  You will generally get a high debt ratio for this type of company. 

And if we talk about the low debt-equity ratio  So you will get a lower debt-equity ratio for retail companies.  The debt-equity ratio of software companies or service companies will be low.  Now let’s quickly calculate the debt-equity ratio. 

you can open the financials of any company.  On the left-hand side of the financials, you can see the balance sheet, profit, and loss statement We have opened the balance sheet. From here we will get to know the position of equity and debt. 

So here total shareholders funds are total equity In Reliance, We get our total equity from here  Now we want a long-term debt-equity ratio  What is our total debt  If we add 81,596 and 15,239 so we the total debt of 96,835  I write here,96,835  Divided by total shareholders funds  Total equity is 3,14,632  So after calculation, it will be approximately 0.31  You don’t have to do the calculation.  Here you get the ratios directly  Let us see the ratios as well  Here in the profitability ratio,

it is showing 0.31 total debt-equity  So you don’t need to calculate by yourself.  But you should understand the interpretation.  This is a comfortable position  It is less than 1.  The debt-equity ratio is 0.31 Which means the debt is 30% compared to equity.  We saw the ratio of Reliance only.  Now if we want to compare with the competitor.  Indian oil is its competitor and it is also in the refining business.  We can check its ratios. 

We come across the ratios of Indian Oil.  Let’s look at total debt-equity  Its debt-equity is 0.50.  That means Its debt-equity ratio is slightly higher  Again it is also in a comfortable position.  But if we compare both the companies, then Reliance is in a better position in the comparison of the debt-equity ratio  So similarly, we should check all the ratios  When we do a fundamental analysis of any stock or a company,  I have already made a post on many of these ratios  And I will cover all these ratios in upcoming posts.  so keep reading these posts I hope you liked this post

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