Decoding ratios debt to equity, debt to asset, equity multiplier

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Decoding ratios debt to equity, debt to asset, equity multiplier

  1. 1. Decoding Ratios: Debt to Equity, Debt to Asset, Equity Multiplier
  2. 2. You must agree that ratios play a significant role in analyzing the status of a business. Let us see three of such noteworthy ratios here and decode them.
  3. 3. Solvency Ratios  Solvency Ratio is a umbrella term that covers all financial ratios that make a comparison between the capital and the borrowed funds of an owner.  Major solvency ratios include • Debt to Equity Ratio = (Total Debt / Total Equity) • Debt to Asset ratio = (Total Debt / Total Assets) • Equity multiplier = (Total Assets/ Total Equity)  Irrespective of the level of sales, organization must be able to fulfill its debt obligations, thus, high level of leverage makes business more prone to downturns in a business cycle  A higher percentage of equity is viewed as a measure of financial stability.
  4. 4. 1. Debt to Equity Ratio  Debt to Equity ratio measures the long term solvency and the capital structure of a company.  It helps in figuring out the percentage of debt and equity in the balance sheet of a firm.  A greater percentage of shareholders equity shows excess of finance which safeguards the company's leverage.  Debt to Equity Ratio = (Total debt or liabilities)/ (Total Equity)
  5. 5. 2. Debt to Asset Ratio  The long term solvency and the capital structure of a company is being judged by Debt to Asset Ratio.  It shows the percentage of debt in comparison to the assets of a company i.e. examines how many assets of a company are financed by debt.  Debt to assets ratio = (Total debt or liability) / (Total assets)
  6. 6. 3. Equity Multiplier  Equity multiplier ratio helps in analyzing the financial leverage of a company.  It examines the use of debt and shareholder’s equity to purchase the assets that are held by a company.  Equity multiplier = Total Assets/Shareholder’s equity  Higher equity multiplier ratio shows that majority of assets are financed through debt.
  7. 7. Du Pont analysis  Equity multiplier ratio is one of the major components of Du Pont analysis, which helps in calculating Return on equity.  Three different aspects viz. profitability, efficiency and the leverage of a company determine DuPont ROE.  ROE under Dupont Analysis = (Net income/sales) x (Total Assets/Total Equity) x (Net income/Total Equity)
  8. 8. Still got doubts? Transtutors provides a 24*7 online platform where you can ask questions and get almost instant reply and finest answers. With a team of experienced expert tutors from different corners of the world, we promise to deliver answers that can fetch you top grades. Ask any question on Equity multiplier or Finance in general and get best answers at a price very nominal only at Transtutors!
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