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Finance: What is the Debt-to-Equity Ratio? 11 Views
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What is the Debt-to-Equity Ratio? Debt to Equity ratio is a metric used to determine the degree of financial leverage a company has. The formula is the quotient of Total Liabilities divided by Total Shareholder Equity. Different industries, especially ones that may be capital intensive, such as aircraft manufacturing, may traditionally have higher Debt to Equity ratios than those with relatively low overhead, such as IT. If a company’s growth and profits continue to increase, investors are willing to accept higher debt to equity ratios, such as with Netflix or Amazon. The underlying rationale is that the increased debt funds are being used to gain more market share and increase business in a positive manner that can justify the higher ratios.
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Transcript
- 00:00
finance a la shmoop what is the debt to equity ratio? well simply put this ratio
- 00:08
answers the question who owns the company like if the debt to equity ratio
- 00:14
is high like there's tons of debt and very little equity well, then
- 00:18
essentially the bank or whoever the lenders are owned the company or at [Assets transfer to bank]
- 00:22
least the lion's share of the assets comprising it the opposite is true as
Full Transcript
- 00:26
well of course and you can imagine a well-heeled company with tons of cash
- 00:30
and other assets like land and oil wells and Technology IP and no debt well they
- 00:35
could have a debt to equity ratio of zero so why do you even track this kind
- 00:40
of ratio well when companies are young they tend to not have tons of equity and
- 00:44
over time as they grow and get good at whatever it is they do they will [Clock rapidly ticks forward]
- 00:49
accumulate valuable assets like cash which are tracked as equity or
- 00:54
shareholders equity on the balance sheet that lives right here think about it if [Balance sheet appears]
- 01:00
this side is assets and this side is liabilities well if you're subtracting
- 01:05
liabilities from assets and you still have a lot of assets left over that's a
- 01:09
good thing and that line is tracked right here in the shareholders equity [Shareholders equity highlighted on balance sheet]
- 01:13
line ..........
- 01:16
you have a company with two billion dollars in debt at 5% interest costing a
- 01:20
hundred million bucks a year to rent if the company's shareholders equity is
- 01:23
just 50 million dollars well, the company is essentially owned
- 01:26
predominantly by its debt holders or lenders should something go wrong even a [A bank vault full of money]
- 01:32
little bit wrong well the company will go bankrupt the debt holders would own all
- 01:36
that equity and well spin this around and if the company's equity comprises 10
- 01:40
billion dollars of cash and a bunch of other assets for a total of 20 billion
- 01:44
of equity well then you can imagine the debt to equity ratio of just 10% that's
- 01:49
the equity holders of the company, they'll sleep like babies [Man taking a nap]
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