Want to learn about debt to equity ratio in the financial ratios? It is a financial ratio to indicate the extent to which a company is financing its assets i.e., through shareholders and debt funds.
Debt to Equity is a ratio of loan funds to own funds. In other words, it indicates a relative proportion of shareholders’ funds and Debt funds in financing a Company.
These numbers can also be easily found on the balance sheet of a company. Let’s Understand the meaning from its core.
The Concept of Debt to Equity Ratio
Whenever you want to start any business we all need funds i.e., Money. The needs of funds can be fulfilled by your own pocket or from someone else’s pocket. If you are putting your money then it is known as Own Funds and if the funds are coming from external sources then these are known as Loan Funds. Now if you are getting funds from external sources so what will you give in return.
Let’s take an illustration for a better explanation- If you want to start your business with Rs 1000 (in. Crore) then there are two options for getting the amount. Either if you have full your own capital then you can put and become the sole owner of the business or you can ask your friends or relatives to contribute some money.
So, whenever they contribute money, Would it be your Own Funds or Loan Funds? This totally depends on what they are going to ask in return. There could be two possibilities:
➤ Let’s start with Possibility No 1.
So, let’s suppose they say that they want a fixed interest i.e., 15% of the Fixed interest on the capital they contributed whether you make a profit or incur losses.
So, you help me out what kind of fund you think is this – Own Fund or Loan Fund? Yes, you are thinking right it’s a Loan fund. Or,
➤ Let’s take Possibility No 2.
Your relatives ask that they don’t want a fixed percentage of interest they want some percentage of the profits you are gonna make i.e, in your growth story. If your business grows, the overall profitability grows, if overall profitability grows then the return of those investors who have given their money for investment also grows.
So, if you make Rs 200 profit by investing Rs 1000 (in crore) – Rs 500 From your pocket and Rs 500 from relatives. Then both of you i.e., you and your relatives, have equal control over the profits.
So in Case no 2 we have seen an example of complete Equity whereas in Case no 1 we have seen an example of Equity as well as Debt.
So, now there comes a question of whether Debt is good or Bad for a Company? Having a little bit of debt is not bad at all. The highest Debt to Equity ratio that is acceptable is 2:1 Times (2 times Debt of Equity).
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