Debt to equity ratio

Debt to equity ratio compares debt with equity. It describes lenders’ contribution for each rupee of owners’ contribution.

It is most common leverage ratio used in practice. Debt may include only long-term debt or total debt including both short-term debt and long-term debt. Further, it is more appropriate to use total debt since it captures the total contribution of lenders.

Furthermore, debt will include short-term and long-term borrowings from banks and financial institutions , debentures/bonds, deferred payment arrangements for buying capital equipment ,bank borrowings, public deposits and other interest bearing loan.

What is debt equity ratio?

In simple words, the D/E ratio shows how much a debt company has compared to its assets. Further, higher D/E ratio indicates the company may have a more tough time covering its liabilities.

How to calculate debt equity ratio?

D/E = Short-term debt + Long-term debt ÷ Share capital + Reserves

= D/E

There is general convention that D/E should remain within the limit of 2:1 . There is no theory for this. It is the convention which banks generally follow while considering giving loan to a firm.

D/E ratio 2:1 means company acquire 2/3rd of its capital financing from debt funds and 1/3rd from its equity capital. For example out of ₹90 a company derives 2/3rd i.e.₹60 from debt funds and 1/3rd i.e. ₹30 from equity capital.

For example XYZ employed ₹1.83 debt for ₹1 of equity which is below the conventional standard 2:1.

Interpretation of D/E ratio

D/E help us in evaluating the financial strategy of a company . The ratio is also help us to find if the company is using equity financing or debt financing to run its business.

High D/E ratio	Low D/E ratio
A high D/E ratio is indicates high risk. It means that the company is using more borrowing to finance its business operations.	Low D/E ratio means company is using more of its own assets and less borrowings.

Refer: https://taxandfinanceguide.com/what-is-pe-ratio/