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Debt to Equity Ratio Formula | Definition | Calculation | Example - YouTube
Channel: WallStreetMojo
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hello everyone hi welcome to the channel
of WallStreetmojo watch the video
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clicking the bell icon friends day we're
going to learn a concept which is known
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as debt to equity ratio formula now this
is a really an important ratio because
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this determines the company's level
of debt that they are exposed to
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compared to their equity the higher the
debt is is not a good sign
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for the company's financial health so
let's see what goes in and around and
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then the nitty-gritty of the debt to
equity ratio from them
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it means the total liabilities divided
by the shareholders equity okay this is
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just a formula but we need to get into
all the details so let's start debt to
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equity ratio formula is viewed as the
long-term solvency ratio it is known as
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the long-term solvency ratio and it is a
comparison between the external finance
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and the internal finance now let's have
a look at the debt to equity formula and
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learn about how things will go about the
debt to equity formula or the ratio is
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equal to the total liabilities divided
by the shareholders equity so this is
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the formula in the numerator we'll take
the total liabilities of the firm and in
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the denominator will consider the
shareholders equity so as a shareholders
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equity includes the preferred stock we
also will also consider that now let's
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understand with the help of an example
so that we have a clear idea
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there's a company called let's see a
youth company and it has some following
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details which are as follows the current
liabilities the non current liabilities
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the common stock and the preferred
stocks so the current liability let's
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say standing at $49,000 non current liability as one
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$1,10,000
$1,11,000 let's
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say the common stocks are having $20,000 shares of let's say 25 each and
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the preferred stock value is $1,40,000 find out the debt
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to equity ratio of the youth company
over here so in this example we have all
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the information and all we need to do is
to find out the the total liabilities of
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the company so I mean you know the total
liability and the total shareholders
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equity of the company let's calculate
that the total liability is basically is
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equal to your current liability plus the
non current liability so that's going to
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be your 49000+1,10,000 that gives us 1 lakh
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60000 as our total liability
the next we have is the total
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shareholders equity which is equal to
your common stock
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it's your is equal to common stock plus
any preferred stock so in our case it's
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going to be 20,000 shares plus 20,000
shall be we have to multiply the price
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20,000 into 25 + 1,40,000 so
that gives a 6,40,000 as of a total
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shareholders equity
so let's finally put down the numbers in
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the formula so our debt to equity
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formula will be the total liabilities
divided by the total shareholders equity
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well the total liabilities goes about 1,60,000 divided by the total
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shareholders equity 6,40,000 so
0.25 so in normal situation
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this is good I mean in normal situation
a ratio of 2:1 is considered quite
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healthy you can see that and from
general perspective youth company use a
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little more external financing and it
will also help them in accessing the
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benefits of the financial leverage
let's understand the explanation part of
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the debt to equity ratio formula see by
using the debt to equity ratio formula
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the investor is gets to know or how a
firm is doing in its capital structure
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right and also how solvent the form is
as whole so when an investor decides to
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invest in the company he or she needs to
know the approach of a company so if the
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total liability of the company if that
is higher or greater compared to the
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shareholders equity I'll just write se
over here then the investor would think
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whether to invest in the company or not
because having too much debt is too
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risky for a firm to be in the long run
so if the liability of the company if it
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is too low compared to the shareholders
equity then the investor would also
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think twice about investing in the
company because then the company's
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capital structure is not conductive
enough to achieve the financial leverage
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so however if the company balance is
both the internal and the external
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finance then maybe the investor would
feel that the company is idle for the
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investment now in this particular graph
what you can see is the ratio that to
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equity ratio of PepsiCo or Pepsi
basically the debt to equity ratio right
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from 2009 onwards as you can see there
was a rise then there was a fall then it
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took her eyes it was stable there was a
I mean there was a slight rise in that
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then it took a huge round up in 2014
around so you can see that it was around
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0.5 X close enough for that around 2009
2010 however it started rising rapidly
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and is at 2.79
- currently and looks like an over
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leveraged situation at this very moment
you can see this example was just taken
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to make you understand that how you
analyze this particular ratio for any
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company now what is exactly the use of
the debt to equity ratio formula
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see the formula for debt-to-equity ratio
is very common ratio in terms of the
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solvency now if the if an investor wants
to know the solvency of the of the
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company debt to equity ratio will be the
first ratio to cross the mind see by
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using the debt recovery ratio the
investor not only understands the
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immediate stance of the company but also
can understand the long-term future of
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the company now for example let's let's
take an example if a company is using
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too less of the external finance so
let's say the external finance is less
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users is too less you can say that and
then through debt to equity the investor
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basically they would be able to
understand that the company is trying to
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become whole equity form over here
because they are not going for more
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external finance and as a result the
form wouldn't be able to use the
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financial leverage in the long run see
taking debt is not a bad thing but over
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leveraging is going to be a turmoil
situation for the company so there
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should be a mix a balance so that's why
we say that 2 :1 ratio is
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considered as good
right now this is the calculator that
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you can use let's say your total debt is
standing at 1 million and your total
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shareholder equity is let's say 5,00,000
so it's 2 if you increase this to 2 it
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will increase to 4 and if you reduce
this to 5 it will reduce to let's make
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it 5,00,000 then it will reduce to 1X so
you make your own assumptions over here
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put down some numbers and you will get
really amazing answers
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try and make your own interpretation if
you consider over here it's a direct
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relationship between the total
liabilities on debt to equity ratio
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formula probably you can consider this
formula by using in various companies
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like you know Jet Airways which is a
highly leveraged company you can see how
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exactly this ratio is working over there
I hope you have got a really great
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insight from this video so that's it for
this particular topic if you have
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learned and enjoyed watching this video
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