## Debt to Equity Ratio Formula | Definition | Calculation | Example

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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

your common stock it’s your is equal to common stock plus

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

really amazing answers try and make your own interpretation if

you consider over here it’s a direct relationship between the total

liabilities on debt to equity ratio formula probably you can consider this

formula by using in various companies like you know Jet Airways which is a

highly leveraged company you can see how exactly this ratio is working over there

I hope you have got a really great insight from this video so that’s it for

this particular topic if you have learned and enjoyed watching this video

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