Saturday 12 January 2019

Debt to equity ratio | Debt Structure

Debt to equity ratio

What Debt to equity ratio? 

The debt-to-equity (D/E) ratio is calculated by dividing a company's total liabilities by its shareholder equity. These numbers are available on the balance sheet of a company's financial statements. The ratio is used to evaluate a company's financial leverage

Personal Finance

Debt-to-Equity ration (D/E) is used to evaluate the strength of companies.  Does it make sense as a metric for your personal finances?  Probably not, for a number of reasons.  Financial metrics that make sense for business rarely make sense for you, personally.


Why Debt to equity ratio?

Well, debt does have a function in our lives and in our economy.   As the Ryder example illustrates, a company can use debt to make money.   You borrow a billion dollars, build a factory, and then you made widgets all day long, which pay down the loan and leave a little money left over.   Sure, you could try to pay cash for such a factory, but since it is hard to save a billion dollars, you'd either have to start small and build your way up (which is hard to do, as you don't have the economies of scale your larger competitors do) or you have to sell off a big chunk of your business to shareholders.  Debt can have a useful function in life.

Similarly, for personal finance, debt can be useful, but only for things that would save you money or make you money.   For example, borrowing for a college degree could be a smart way of using debt, provided you don't get a useless degree in "communications" or "racial studies" or some other such naval-gazing nonsense that colleges like to sell these days (and kids lap up, not thinking about where such degrees will lead them - nowhere).   If you borrow money for a worthless degree, that's idiotic.  If you borrow money for a useful degree, that's smart.

A home mortgage can be a smart debt, provided the mortgage is locking in your payments and saving you money by creating equity in a home (as opposed to a string of rental payments).   Over time, your fixed monthly mortgage will seem small, compared to comparable rents.   But if you get a mortgage to buy a "look at me!" mini-mansion to impress people you don't even know, that is just idiotic and will bankrupt you.  Ditto for serially refinancing your house so you can borrow money to cover your living expenses today.

Really dumb debt is consumer debt - consumer loans for a hot tub or a pool table.  Credit card debt.  Even car loans, particularly if they are for a "look at me!" car that is more about showing off than providing transportation.   And if stretched out to seven years or more, or at a high interest rate, doubly dumb.

And the more debt you take on, the harder and harder it is to bring that D/E ratio down.   If you graduate from college with $100,000 in debt - or more - it may be very hard to ever pay off such a debt.

So yes, the D/E Ratio might make some sense for individuals as well as companies. However if you sit down and calculate your debt to equity ratio you might find yourself getting very depressed.

In addition, as with any ratio, it may not be very instructive. For example, if you had debts of $100 and assets of $1,000, your debt to equity ratio would be 0.1 which would sound very good on paper.   However, it would still mean you're essentially broke.

Moreover since your debt to equity ratio changes over the span of your life, it is more an indica of your age than anything. Nevertheless if you were reaching retirement age and your debt to equity ratio is still 1 or higher you may want to think where this is going.

Exact Formula in the Ready Ratios Analytical Software

Debt-to-equity ratio = F1[Liabilities] / F1[Equity]
F1 – Statement of financial position (IFRS)

What is Debt Structure?

A Debt structure describes a composition period of debt used by companies, whether short, medium or long term, and are influenced by the large debt the small

variety of debt among other things:
  • Short Term Debt
  • Intermediate-Term Debt
  • Long Term Debt

A good debt to equity ratio is around 1 to 1.5. However, the ideal debt to equity ratio will vary depending on the industry because some industries use more debt financing than others. Capital-intensive industries like the financial and manufacturing industries often have higher ratios that can be greater than

Short Term Debt

Short-term Debt funding sources are grouped into:
Passive Decision variable, the amount of funding sources will depend on the other aspects of the decision in accordance with the company's activity. For example: purchase of raw materials in credit, the accruals accounts.
Variable Active Decisions, companies should actively seek and obtain funding sources and in achieving it must have formal agreements to Creditors. For example: Bank debt.
Intermediate-Term Debt

On the type of debt payment is normally repaid debt at a time when assets are financed with debt that is no longer needed. However, the payment is usually done on a regular basis.
The benefits of this debt that the debt can be adjusted with the willingness of cash flow in those debts.

Long-term debt

long-term debt generally has about more than 5 years, some even hold that debt has a period of 10 years.
Long-term debt related to capital structure. If the company borrowed funds and return it within a relatively long period of time then the loans/debts that will be part of the company's capital structure.

Comparison of long term debt and capital loans which are usually defined as capital.
Long-term debt is also formed by extended loans/short term debt as well as medium-term debt, it was seen on the basis of the time of payment of the debt.
The types of long-term debt include:
  • Bonds
  • Mortgages
  • Investment Credit

Considerations In The Decision On Debt

The longer the loan/debt the more secure company because the smaller the risk of bankruptcy, but the cost of the interest is getting bigger.
More likely in extend the term of the debt, then the greater the cost of the extension must be issued and likely will bear the risk of bankruptcy.

The structure of the funding period of

Hedging Approach

is a strategy for financing any assets with a term that is more or less the same as the length of time the assets turnover into cash. This approach is based on the matching principle which States that the source of funds should be tailored to how long those funds required.

Debt to Equity Ratio Formula

Now that we've defined the debt to equity ratio, we'll take a look at how to use it. Below is the formula to calculate the debt to equity ratio:

Debt to equity ratio = Total liabilities / Shareholders' equity

And here are the two elements that make up the formula:
  • Total liabilities: Total liabilities represent all of a company's debt, including short-term and long-term debt, and other liabilities (e.g., bond sinking funds and deferred tax liabilities).
  • Shareholder's equity: The shareholder's equity is calculated by subtracting total liabilities from total assets. Total liabilities and total assets are found on a company's balance sheet.

Credit Risk Analysis: Debt-to-Equity Ratio

If recent financial market events have taught us anything, it's that a) leverage can work both ways, and b) when leverage works against an individual/corporation/investment entity, the results can be fairly disastrous. Although the pair of statements above are essentially commonly held knowledge, the behavior exhibited by market participants throughout the past 20 years was nothing if not a blatant disregard for this reality. Moving forward, it will be more prudent than ever for investors to perform a sober assessment of a corporation's use of leverage.

At the heart of credit risk analysis is a corporation's solvency, or in other words, it's ability to function as a going concern, capable of avoiding financial distress. The cornerstone of evaluating
solvency is the Debt-to-Equity Ratio, which as the name implies, looks at a firms absolute debt level in terms of a multiple of total stockholders' equity. Both parts of the equation can be found on the balance sheet, and are plugged in as follows:

Debt-to-Equity Ratio = Total Liabilities / Total Stockholders' Equity

Verizon's (VZ) Debt-to-Equity Ratio is calculated as follows:

Debt-to-Equity Ratio = Total Liabilities / Total Stockholders' Equity
= $160,646M / $41,706M
= 3.85

In other words, for every dollar of Shareholders' Equity, Verizon holds $3.85 worth of debt. This ratio will obviously fluctuate greatly based upon the industry, and the composition of the firm's funding sources, i.e. relative breakdown of debt v equity funding. The chart below compares Verizon with seven other large firms from a debt-to-equity ratio standpoint:

Clearly, the debt-to-equity ratio needs to be examined from within the context of the individual firm and industry as a whole. For instance, there are two reasons why I wouldn't be alarmed at Verizon's high ratio of debt funding. First, it's subscriber based business provides relatively stable and predictable cash flows; a distinction that translates into ample access to the bond market. Secondly, a major portion of Verizon's borrowing activity over the past couple of years has been geared towards investment in it;s FiOs network. I haven't assessed that product from a consumer standpoint, but feel certain that Verizon will be able to leverage it's market leadership position into a substantial FiOs subscriber base.

Step 2 in the credit risk analysis process is determining the firms ability to cover interest payments from internally generated cash. That ratio will be addressed in a future article.


the company's Funding comes from loans/debt both within short, medium, or long periods of time. It also depends from the big to the small company's activity. Consideration is taken to do a debt not only based on the needs of the company, but must be based on the risk of losses or bankruptcies that will be experienced after making the debt.

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