Knowing the debt equity ratio of your company is useful in two ways. First, it allows you to have control over your company’s financial health. If you regularly evaluate your debt equity ratio, you will be able to monitor purchases of inventory and other fixed assets. Fixed assets cannot become liquid in a short period of time. Secondly, it will reveal your company’s credit worthiness or net worth, which will help lenders with their decisions about whether to give you a loan. Lenders have one main concern: does the borrower have the ability to repay the full amount of a given loan?
The formula for finding what your company’s debt equity ratio is:
Total Debt (Short Term and Long Term) divided by Total Equity (Owners and Shareholders)
Dividing total debt by total equity will get the percentage of debt to equity. If the percentage is high, lenders may see the company as a high risk with an inability to repay a loan. If this percentage is low, lenders are more likely to make the loan as this percentage reveals financing has been used conservatively.
If you are selling a company, a healthy debt equity ratio will enhance the buyer’s interest. If the buyer needs financing, his company has a better chance of getting a loan to do so.
Where do you get the figures to make this formula work? Begin with your company financials. Start with the Balance Sheet. An accountant will be able to more clearly set out the figures for you. The Balance Sheet consists of your company's assets, liabilities, and equity.
Assets include cash, short term investments (short period of time to liquidity), inventory, receivables (notes), and expenses already paid. Fixed assets cannot become easily liquid in one year. They include land, buildings, equipment and machinery, as well as leases that are capitalized.
Liabilities include accounts payable, notes payable and, yes, income tax. Long term liabilities include any long term debt, expenses on capitalized leases, and income tax that has been deferred.
Equity includes stocks (Common and Preferred), any additional monies that have been paid into Common Stock, and any retained earnings.
To improve your debt equity ratio, monitor your financials regularly, satisfy as many debts as possible, maximize earnings by regulating purchasing of inventory and fixed assets, pay off lines of credit, and hold bonuses until after the balance date. Borrow after the balance date.
When submitting financials to a lender, it is wise to have an accountant review your figures. The formula to find debt equity ratio is simple for a small company. Larger and more complex companies need an accountant to place the company in its best light.