Learn On Your Own Debt Equity Ratio:

Debt Equity Ratio is the ratio that indicates the pattern of company's finance between debt- capital and equity capital. Here "Debt Capital" refers to that portion of company's assets that are being financed through "Loan" or 'Debt' that has some intrinsic interest-bearing financial obligations. For example debentures, loans, redeemable preference shares, bank overdrafts, etc

"Equity Capital" refers to the capital contributed by the equity share holders of the firm. It is that invested money which, in contrast to debt capital, does not require to be repaid to the investors in the normal course of business. Such a shareholder has to share the profits and also bear the losses incurred by the company.

Capital-intensive industries tend to have higher debt-to-equity ratios than low-capital industries because such industries need to invest more on property, plants and equipment to operate. This is why comparison of debt-to-equity ratios is generally most meaningful among companies within the same industry, and the definition of a "high" or "low" ratio should be made within this context.

Lenders and investors usually prefer low debt-to-equity ratios because their interests are better protected in the event of a business decline. Thus, firms with high debt-to-equity ratios may not be able to attract additional capital.

The ratio of debt-to-equity should be decided on the company's ability to repay its obligations. If the ratio is increased, it signifies that the company is being financed more by creditors rather than from its own financial sources which may be a dangerous. Lenders and investors usually prefer low debt-to-equity ratios because their interests are better protected in the event of a business decline.

If a lot of debt is used to finance increased operations, the company could potentially generate more earnings than it would have without this outside financing. If this were to increase earnings by a greater amount than the debt cost (interest), then the shareholders benefit as more earnings are being spread among the same amount of shareholders. However, the cost of this debt financing may outweigh the return that the company generates on the debt through investment and business activities and become too much for the company to handle. This can lead to bankruptcy, which would leave shareholders with nothing.