abhishreshthaa
Abhijeet S
It comments on the long-term capital structure of the company.
Debt here does not include current liabilities.
Shareholders’ funds include all share capital (equity and preference), reserves and surplus less: accumulated losses and fictitious assets.
Another alternative is to take ‘All Debt’ in the numerator ie both long term and current liabilities. The rationale of this option is that even though current liabilities are changing, they form by and large a permanent part of the business and therefore should be included.
Significance:
1. The ratio shares favorable and unfavorable financial position of the concern
2. It shows long term capital structure.
3. The lower ratio indicates the high margin of safety to the creditors.
4. The higher ratio indicates risk involved with respect to creditors .It indicates to much of dependences on long term debt.
Example for understanding
The Debt- Equity ratio reflects the relative contribution of creditors and owners in the capital structure. Eg. If a company has a debt-equity ratio of 3:2, it implies that out of the total capital, debt is 3/5 and equity is 2/5. Generally financial institutions prefer a debt-equity ratio of 2:1.
A low ratio is favorable from a long-term creditor’s point of view since it gives them a sufficient safety margin and protection against shrinkage in assets.
For the shareholders the servicing of debt (payment of interest and principal) is less burdensome but they are deprived of the benefits of trading on equity or leverage.
A higher ratio indicates too much dependence on debt and a heavy burden of interest and principal payments but the shareholders may gain due to retention of control (as debt carries no voting power) and a higher EPS.
Debt here does not include current liabilities.
Shareholders’ funds include all share capital (equity and preference), reserves and surplus less: accumulated losses and fictitious assets.
Another alternative is to take ‘All Debt’ in the numerator ie both long term and current liabilities. The rationale of this option is that even though current liabilities are changing, they form by and large a permanent part of the business and therefore should be included.
Significance:
1. The ratio shares favorable and unfavorable financial position of the concern
2. It shows long term capital structure.
3. The lower ratio indicates the high margin of safety to the creditors.
4. The higher ratio indicates risk involved with respect to creditors .It indicates to much of dependences on long term debt.
Example for understanding
The Debt- Equity ratio reflects the relative contribution of creditors and owners in the capital structure. Eg. If a company has a debt-equity ratio of 3:2, it implies that out of the total capital, debt is 3/5 and equity is 2/5. Generally financial institutions prefer a debt-equity ratio of 2:1.
A low ratio is favorable from a long-term creditor’s point of view since it gives them a sufficient safety margin and protection against shrinkage in assets.
For the shareholders the servicing of debt (payment of interest and principal) is less burdensome but they are deprived of the benefits of trading on equity or leverage.
A higher ratio indicates too much dependence on debt and a heavy burden of interest and principal payments but the shareholders may gain due to retention of control (as debt carries no voting power) and a higher EPS.