This document discusses the debt to equity ratio, which is a financial ratio that measures a company's financial leverage by comparing its total liabilities to its total shareholders' equity. It is calculated by dividing a company's total liabilities by its shareholders' equity. A high debt to equity ratio means the company has more debt than equity, making it riskier as it must pay off debt before equity shareholders if it goes bankrupt. The ideal ratio depends on the industry, so companies must be compared to their peers. The ratio helps investors assess credit risk but should be considered along with other financial metrics.

1. NSE IFSC
Debt to
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2. As an investor, you must evaluate the company before making a decision on whether
to invest in it or not. This evaluation would help you take trades with most potential
for profit and least probability of risk. Such evaluation is carried out through
Fundamental Analysis. Fundamental Analysis involves evaluating the company’s
financial status by studying its Balance Sheet, Income Statement (also called Profit and
Loss Statement), Cash Flow Statement, and its Financial Ratios. Out of these, Financial
Ratios help us compare two or more financial parameters of the company to
understand its financial status better. Using these ratios, you can understand the
company’s financial health and also compare the company to its peers that operate in
the same industry or sector. One such parameter is Debt to Equity Ratio. In this blog,
we will find out more about Debt to Equity Ratio and the debt to equity ratio formula.

3. Debt and Equity
In order to understand this ratio, we first need to understand the definition of each
term. Every company raises capital in two ways, namely, Debt financing and Equity
Financing.
Debt Financing is essentially borrowing money from a creditor by taking a loan at a fixed
interest rate. Equity financing refers to issuing of equity shares of the company to the
general public (through IPOs and FPOs). Equity financing is more expensive, dilutes
earnings per share of existing shareholders, and is a time consuming process.
Debt financing involves only interest payments as the primary cost. This can be
deducted from their overall tax liability and thus makes it the preferred form of
financing. However, Debt financing comes with Credit Risk. In the scenario where the
borrower fails to repay the principal or interest amount, investors (creditors) are left
with no choice but to declare it as a non-performing asset.

4. Debt to Equity Ratio Formula and How to Interpret It
Now, let us understand what is Debt to Equity Ratio and how it is calculated.
As the name suggests, this financial ratio calculates the company’s total debt versus
the equity. Calculating and evaluating the Debt to Equity Ratio tells investors how
much of the company’s assets are debt financed. This would aid them in measuring
credit risk in case the company is liquidated.
Debt to Equity Ratio is also known as Gearing Ratio or Risk Ratio. It comes under
Leverage Ratios or Solvency Ratios. These ratios help analysts compare the debt level
of a company to its equity and assets. This allows them to understand the company’s
ability to meet its long term debt obligations.

5. Debt to Equity ratio is calculated by dividing total liabilities of the company by its
shareholders’ equity.

6. Where, Total Liabilities refers to long-term debt with a minimum maturity period of more than
five years. It is a non-current liability and is not the same as short-term debt which must be repaid
within five years.
Quick Ratio or Current Ratio would be better suited to understand the company’s ability to repay
its short-term debts or liabilities.
As Debt to Equity Ratio calculates whether the company can repay its long-term debt, we can
deduce that a high value for this ratio would not be a favourable sign. A high debt to equity ratio
would signify that the company does not have enough equity to repay its debts and thus makes it
a high-risk investment. This is because if a company goes bankrupt, on liquidation, it is first
obligated to pay off its debt liabilities before it can pay back any investments made by equity
shareholders.
A company with a Debt to Equity Ratio of 1:1 is considered to be safer as the company has equal
amount of debt and equity. Whereas, a company with a debt to equity ratio of 2 or more is
considered to be a risky investment since the company owes twice the amount of debt as
compared to its equity.

7. Ideal Debt to Equity Ratio
When evaluating a company, we must consider its financial ratios and also compare
them to the other companies operating in the same sector or industry. Knowing the
ideal debt to equity ratio for a company aids us in assessing the company correctly.
Some companies may have negative debt to equity ratios. It signifies that the company
pays high interest on its debt obligations and earns low return on equity. Or it may
indicate that the company has negative networth. For example, SpiceJet has a debt to
equity ratio of -0.25.
Some companies have a low or zero debt to equity ratio. Generally, these are considered
safer investments but it may also indicate that the company is not taking advantage of
financial leverage for increasing its profits. It may not be utilizing the opportunity to
expand its business and increase its profits by taking debt. At times, the company could
have low debt to equity ratio but not perform well in other aspects, making it a bad
investment.

8. However, assuming that a company is a bad investment based only on its high debt to
equity ratio is also incorrect. Some industries are capital intensive and thus have high
Debt to Equity Ratios. Companies operating in the automobile, power, utilities, and
financial sector typically have high debt to equity ratio while also being good avenues for
investment. This makes it necessary to consider the average debt to equity ratio of the
industry before making a decision.
The interest Coverage Ratio is an important financial parameter that can help us make
the final decision in case of companies having a high debt to equity ratio. This ratio tells
us about the company’s ability to pay the interest due on their liabilities. High Interest
Coverage Ratio, above 1.5 is considered to be a good sign for creditors. An interest
coverage ratio of less than 1.5 indicates that the company may default on its interest
payments and are not good investments.

9. Implications of High Debt to Equity Ratio
A high debt to equity ratio indicates several factors about the company. We
shall discuss them in this segment.
Reduction in Equity Ownership: A high debt to equity ratio signifies that
shareholders’ equity is less and thus they have lower claim on the company’s
earnings and assets as compared to the lenders and creditors. This also means
that a large portion of the earnings is used for debt servicing, reducing the
earnings per share for the shareholders.

10. Limitations of Debt to Equity Ratio
The most common mistake made by investors when considering the debt to equity
ratio of the company is not checking the industry standard. As different industries
have different capital requirements and different time frames for growth, a debt to
equity ratio levels for each industry are different. To rectify this error, we must
compare the ratio with the level for the rest of the companies operating in the same
industry.
Furthermore, while Debt to Equity Ratio is a good parameter to assess the financial
health of the company, we must also remember to check other financial ratios of the
company before making our investment decisions. At the very least, an investor
must check whether the company has a good return on equity before investing.