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Measuring Solvency and Capital Structure

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Debt to Equity Ratio

 

Summary of Measuring Solvency and Capital Structure. Abstract

 

D/E RatioTo determine and measure the solvency and capital structure of a company, the D/E Ratio is used. It indicates how much the company is leveraged (in debt) by comparing what is owed to what is owned. In other words it measures a company's ability to borrow and repay money.


The D/E Ratio is closely watched by creditors and investors, because it reveals the extent to which company management is willing to fund its operations with debt, rather than equity. Lenders such as banks are particularly sensitive about this ratio, since an excessively high ratio of debt to equity will put their loans at risk of not being repaid. Possible actions by banks to counteract this problem are the use of restrictive contracts that force excess cash flow into debt repayment, restrictions on alternative use of cash, and a requirement for investors to put more equity into the company themselves.


Its calculation is fairly simple:


Divide Total Debt (= Total Liabilities) by Total Equity. Can be multiplied with 100 to get a percentage.

Note that the Debt figure should include all operating and capital lease payments.


Sometimes only long-term debt is taken into account in the numerator to look at the long term debt to equity capital structure.


Comparing the result with industry peers may prove useful. It is recommended to use this ratio over a period of several years and additionally take into account WHEN certain repayments are due as this can make a major difference for the solvency of the company.


Compare with the Debt to Equity Ratio:  Cash Flow from Operations  |  Dividend Payout Ratio

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