|Debt to equity ratio|
Debt to equity ratio
The two most basic sources of funds for a company are debt and equity. Debt and equity both have unique characteristics and the relationship between these two sources is widely used to evaluate the financial strength of a business.
Debt requires maintenance in form of interest payments and on maturity are payable whether a company has earned or lost income. The only benefit is that interest payments are tax deductable unlike dividend payments which are not. Also equity does not require fixed interval payments and dividends are only paid on earned income.
The debt to equity ratio is the most widely used ratio for debt to equity analysis. There are however some notable warnings on this ratio. First is that book value of debt is typically much closer to market value than shareholder equity. Second is the definition of what is debt. Are deferred taxes or minority interests included in debt? It is quite common for these two items to be left out since it does not involve a firm obligation. Depending on what is considered debt the ratio can have quite different results.
To calculate debt to equity ratio
Debt to equity = Total liabilities / Owner's equity