The debt-to-equity ratio is a financial ratio that measures the amount of a company's debt relative to its equity. It is calculated by dividing the company's total debt by its total equity.
Formula
Debt / Equity, where
Debt - It covers all long term or non-current liabilities of the company
Equity - It covers shareholders' funds i.e. share capital + Reserves and Surplus
How to Calculate
Debt covers all the non-current liabilities of the business. Its sub heads are as follows :
| S No | Sub Head | Items | Brief Explanation |
| 1 | Long term borrowings | Debentures | |
| Bonds | |||
| Term Loans from a) Banks b) Other Parties | |||
| 3 | Public Deposits | ||
| Other Loans and Advances | |||
| 2 | Deferred Tax Liabilities (Net) | Income Tax on (Accounting Income - Taxable Income) | |
| 3 | Other Long term Liabilities | Any long-term liability other than long term borrowings | |
| Trade Payables | Sundry Creditors and Bills Payable | ||
| Others | Premium on redemption of debentures if debentures are long term | ||
| Premium on redemption of preference shares if preferences shares are long term | |||
| Advances from Customers - Long term | |||
| 4 | Long Term Provisions | Provision for Employee Benefits | Provision for Gratuity, Leave Encashment, Provident Fund, etc. |
| Others | Provision for warranty claims | ||
Equity Means the Shareholders funds.Its sub heads are as follows :
| S No | Sub Head | Items | Brief Explanation |
| 1 | Share Capital | (Equity + Preference) and (Cash + Non Cash) | Discussed in details in Company Accounts Chapter |
| Reserves and Surplus | Amount set aside out of profits. For each item show Opening Balance, Additions/Deductions and Closing Balance+G8 | ||
| Capital Reserve | Reserve created out of Capital Profits | ||
| Capital Redemption Reserve | Reserve created when company purchases its own shares out of free reserves | ||
| Securities Premium Reserves | Excess of Issues price over Face Value | ||
| Debenture Redemption Reserve | Reserve created for the purpose of redemption of debentures | ||
| Revaluation Reserve | Reserve created due to upward revision of assets value | ||
| Share Options Outstanding Amount | Difference between Market Value and Issue price of shares issued to employees | ||
| Other Reserves | |||
- Workmen Compensation Reserve | |||
- Investment Fluctuation Reserve | |||
- Subsidy Reserve | |||
- General Reserve | |||
| Surplus | Balance in Statement of Profit & Loss A/c i.e. Accumulated profits not appropriated or distributed as dividends |
Interpretation
The debt-to-equity ratio is used to evaluate a company's financial leverage, or the extent to which the company is using debt to finance its operations and growth. A high debt-to-equity ratio may indicate that a company has high levels of debt relative to its equity, which could be a sign of financial risk. On the other hand, a low debt-to-equity ratio may indicate that a company has low levels of debt relative to its equity, which could be a sign of financial stability.
A low debt equity ratio is always good for business. The higher the debt equity ratio it shows that the company is more leveraged and runs a higher risk when the business cycle turns adverse.
The lenders will be reluctant to give loans at favorable terms to a company which has a high debt equity ratio