Debt to Equity ratio

This ratio indicates how much debt the company has got for every Rs 1 of shareholder’s equity.

Formula

                 Debt to Equity Ratio = Toral Borrowings / Shareholder’s Equity

Example

If the company has a total borrowing (debt) of Rs 1000 Cr and the Shareholders’ equity is Rs 500 Cr. The D/E ratio is 2 (1000 / 500).

For every Rs 1 of shareholder’s equity, the company has a debt of Rs 2.

How to use it practically

The high Debt to Equity ratio tells that, the company has got high borrowing relative to shareholder equity. Generally, capital-intensive businesses like manufacturing may have a high D/E ratio because they need to invest a huge amount of money upfront to get profit in the future.

But as individual investors, we must prefer investing in a business that requires low or no debt from banks, because their business itself is so strong that, the business is generating a huge amount of profit.

The trend of the D/E ratio must be kept in check by the management so that, interest payment doesn’t become a burden for the company.

Normally debt to equity ratio of 1 or below is considered to be a prudent metric. In case, If you want to invest in high debt companies look for two things. First – check whether the company has got high OPM, Second check the interest coverage ratio of the company.

Related Terms

ROIC

ROIC indicates how much profit is generated by the company for every Rs 1 of invested capital....

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