It is a debt ratio used to measure the financial leverage of a company, calculated by dividing the total liabilities by stockholder equity of a company. This ratio shows how much debt a company has in order to finance its assets relative to the amount of value represented in stockholder equity. Similarly, it is a percentage of financing of a company occurring from investors and creditors.
Explanation of Debt to Equity Ratio
Debt to equity ratio is often used for gauging the extent to which a company raises debt for leverage. High debt to equity ratio means company has an aggressive strategy of financing for growth using the debts, but high level of risk is involved with aggressive financing strategy. It may result in the volatile earnings resulting from the additional interest expense.
Generally, high debt to equity ratio is a clear indication that a company is not able to in generating the sufficient cash to cover its financial obligations. However, low debt to equity ratio indicates that a company is not taking advantage of increased profits from the financial leverage. Investors or lenders normally prefer low debt to equity ratio because their interests are secured even the business is declining. Consequently, companies with high debt to equity ratio may not be able to attract additional funds.