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going to learn a concept which is known as debt to equity ratio formula now this
is a really an important ratio because this determines the company’s level
of debt that they are exposed to compared to their equity the higher the
debt is is not a good sign for the company’s financial health so
let’s see what goes in and around and then the nitty-gritty of the debt to
equity ratio from them it means the total liabilities divided
by the shareholders equity okay this is just a formula but we need to get into
all the details so let’s start debt to equity ratio formula is viewed as the
long-term solvency ratio it is known as the long-term solvency ratio and it is a
comparison between the external finance and the internal finance now let’s have
a look at the debt to equity formula and learn about how things will go about the
debt to equity formula or the ratio is equal to the total liabilities divided
by the shareholders equity so this is the formula in the numerator we’ll take
the total liabilities of the firm and in the denominator will consider the
shareholders equity so as a shareholders equity includes the preferred stock we
also will also consider that now let’s understand with the help of an example
so that we have a clear idea there’s a company called let’s see a
youth company and it has some following details which are as follows the current
liabilities the non current liabilities the common stock and the preferred
stocks so the current liability let’s say standing at \$49,000 non current liability as one \$1,10,000
\$1,11,000 let’s say the common stocks are having \$20,000 shares of let’s say 25 each and the preferred stock value is \$1,40,000 find out the debt to equity ratio of the youth company
over here so in this example we have all the information and all we need to do is
to find out the the total liabilities of the company so I mean you know the total
liability and the total shareholders equity of the company let’s calculate
that the total liability is basically is equal to your current liability plus the
non current liability so that’s going to be your 49000+1,10,000 that gives us 1 lakh 60000 as our total liability
the next we have is the total shareholders equity which is equal to
any preferred stock so in our case it’s going to be 20,000 shares plus 20,000
shall be we have to multiply the price 20,000 into 25 + 1,40,000 so
that gives a 6,40,000 as of a total shareholders equity
so let’s finally put down the numbers in the formula so our debt to equity formula will be the total liabilities
divided by the total shareholders equity well the total liabilities goes about 1,60,000 divided by the total shareholders equity 6,40,000 so
0.25 so in normal situation this is good I mean in normal situation
a ratio of 2:1 is considered quite healthy you can see that and from
general perspective youth company use a little more external financing and it
will also help them in accessing the benefits of the financial leverage
let’s understand the explanation part of the debt to equity ratio formula see by
using the debt to equity ratio formula the investor is gets to know or how a
firm is doing in its capital structure right and also how solvent the form is
as whole so when an investor decides to invest in the company he or she needs to
know the approach of a company so if the total liability of the company if that
is higher or greater compared to the shareholders equity I’ll just write se
over here then the investor would think whether to invest in the company or not
because having too much debt is too risky for a firm to be in the long run
so if the liability of the company if it is too low compared to the shareholders
equity then the investor would also think twice about investing in the
company because then the company’s capital structure is not conductive
enough to achieve the financial leverage so however if the company balance is
both the internal and the external finance then maybe the investor would
feel that the company is idle for the investment now in this particular graph
what you can see is the ratio that to equity ratio of PepsiCo or Pepsi
basically the debt to equity ratio right from 2009 onwards as you can see there
was a rise then there was a fall then it took her eyes it was stable there was a
I mean there was a slight rise in that then it took a huge round up in 2014
around so you can see that it was around 0.5 X close enough for that around 2009
2010 however it started rising rapidly and is at 2.79
– currently and looks like an over leveraged situation at this very moment
you can see this example was just taken to make you understand that how you
analyze this particular ratio for any company now what is exactly the use of
the debt to equity ratio formula see the formula for debt-to-equity ratio
is very common ratio in terms of the solvency now if the if an investor wants
to know the solvency of the of the company debt to equity ratio will be the
first ratio to cross the mind see by using the debt recovery ratio the
investor not only understands the immediate stance of the company but also
can understand the long-term future of the company now for example let’s let’s
take an example if a company is using too less of the external finance so
let’s say the external finance is less users is too less you can say that and
then through debt to equity the investor basically they would be able to
understand that the company is trying to become whole equity form over here
because they are not going for more external finance and as a result the
form wouldn’t be able to use the financial leverage in the long run see
taking debt is not a bad thing but over leveraging is going to be a turmoil
situation for the company so there should be a mix a balance so that’s why
we say that 2 :1 ratio is considered as good
right now this is the calculator that you can use let’s say your total debt is
standing at 1 million and your total shareholder equity is let’s say 5,00,000
so it’s 2 if you increase this to 2 it will increase to 4 and if you reduce
this to 5 it will reduce to let’s make it 5,00,000 then it will reduce to 1X so
you make your own assumptions over here put down some numbers and you will get