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    Accounting Ratios

    Accounting Ratio of Liquidity Ratio, Profitability Ratio, Leverage Ratio, Activity Ratio is used to analyze financial statement.Ratio formula explained here

    Accounting Ratios

    Updated on :  Feb 17, 2022 - 12:14:49 PM

    11 min read.

    Accounting ratio is the comparison of two or more financial data which are used for analyzing the financial statements of companies. It is an effective tool used by the shareholders, creditors and all kinds of stakeholders to understand the profitability, strength and financial status of companies. This is also widely known as financial ratios based on which business performance can be monitored and important business decisions are made.

    All these types of ratios are used for monitoring the business performance and comparing the business results with competitors. Let’s discuss each of the ratios in detail below-

    Liquidity Ratio

    Liquidity ratio helps in measuring the cash sufficiency of an enterprise to pay off its short-term liabilities. A High liquidity ratio ensures the company is in a good position to pay its creditors. The liquid ratio of 2 or more is considered acceptable. Listed below are some of the commonly used liquidity ratios:

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    Sl.No Ratio Name Formula Used for Detail

    1 Current Ratio {(Current Assets)/(Current Liabilities)} 1. One of the commonly used liquidity ratios is the current ratio which compares the current assets to current liabilities held by the business Current assets include cash, inventory, accounts receivable etc

    2. This ratio is used to check if the company will be able to pay its debts which are due in next 12 months Current liabilities include accounts payable, income tax payable and any other current liabilities

    2 Quick Ratio {(Quick Assets)/(Current Liabilities)} 1. It is similar to current ratio except that this uses only quick assets which are easy to liquidate. To calculate the Quick assets, inventory and prepaid expenses which are difficult to liquidate are to be removed from the current assets.

    2. This is also known as Acid test

    3 Cash Ratio {(Cash + Marketable securities )/(Current Liabilities)} 1. This ratio considers only those current assets which are immediately available to the company to pay its debts. Only cash and marketable securities are considered for current assets.

    2. Business is considered as financially sound if it has a cash ratio of 1 or more.

    Profitability Ratio

    Profitability ratio is generally used to determine how well the business is generating profits from its operations. Profit is the balance of income earned after deducting all related expenses. Given below are some of the commonly used profitability ratios:

    Edit Sl.No

    Particular Formula Used for Detail

    1 Gross Profit Margin {(Revenue – Cost of Goods Sold (COGS))/(Revenue)} 1. Higher the gross profit margin, more efficient is the business operation. Revenue is the sales income and COGS includes raw material, labour, and other production expenses

    2. Gross Profit ratio is used to compare the business performance with its previous period or even with its competitors

    2 Operating Margin {(Gross Profits- Operating Expense)/(Revenue)} 1. Unlike Gross profit ratio, this includes more expenses and hence it is used to ascertain companies profitability more efficiently From the gross profits, operating expenses such as selling and distribution cost, administration cost etc are deducted to arrive at operating margin

    3 Profit Margin {(Revenue – Operating expense + non-operating income-Interest Expense- Income taxes)/(Revenue)} 1. This ratio helps an investor to know how much profit is generated from the total revenue of the business As the formula itself explains, the profit margin is arrived from the revenue after adjusting all operating and non-operating expense and income

    2. The overall functional efficiency of an enterprise can be ascertained apart from its core business

    4 Earnings per Share (EPS) {(Net Income – Preferred Dividend)/(Weighted Average Outstanding Shares)} EPS is more important to shareholders since it helps in determining the return on investment Generally weighted average Outstanding shares are used since outstanding shares can change over time

    Higher the EPS, higher is the stock price of the company Sometime Diluted EPS are used which includes options, convertible securities and warrants outstanding which affects outstanding shares

    Leverage Ratio

    Leverage ratio measures the utilization of borrowed money by the business. It helps to identify the financial stability of the business by analyzing the total debt of the company.

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    Sl.No Particular Formula Used for Example

    1 Debt to Equity Ratio {(Total Debt)/(Total Equity)} 1. Business with high debt Equity ratio indicates that it is more dependent on debts for operation Total Debt includes both long term and short term debts held by the company.

    2. This is also known as Gearing ratio which is used by Investors and Creditors to analyze the company’s financial leverage

    2 Debt to Asset Ratio {(Total Debt)/(Total Asset)} 1. Debt to Asset ratio can be used to determine if the business will be able to pay all of its debts if the business is closed immediately It includes all the debt and assets of the company but there are different variations of this formula where only certain assets or specific liabilities are included

    2. A company having a debt to asset ratio of less than 1 is considered as good for investment. If the ratio is greater than 1, the company is considered as highly leveraged

    स्रोत : cleartax.in

    Debt to Equity Ratio

    The Debt to Equity Ratio is a leverage ratio that calculates the value of total debt and financial liabilities against the total shareholder’s equity.

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    Debt Equity Ratio

    How much leverage does a company have?

    Updated May 7, 2022

    What is the Debt to Equity Ratio?

    The Debt to Equity ratio (also called the “debt-equity ratio”, “risk ratio”, or “gearing”), is a leverage ratio that calculates the weight of total debt and financial liabilities against total shareholders’ equity. Unlike the debt-assets ratio which uses total assets as a denominator, the D/E Ratio uses total equity. This ratio highlights how a company’s capital structure is tilted either toward debt or equity financing.

    Debt to Equity Ratio Formula

    Short formula:

    Debt to Equity Ratio = Total Debt / Shareholders’ Equity

    Long formula:

    Debt to Equity Ratio = (short term debt + long term debt + fixed payment obligations) / Shareholders’ Equity

    Debt to Equity Ratio in Practice

    If, as per the balance sheet, the total debt of a business is worth $50 million and the total equity is worth $120 million, then debt-to-equity is 0.42. This means that for every dollar in equity, the firm has 42 cents in leverage. A ratio of 1 would imply that creditors and investors are on equal footing in the company’s assets.

    A higher debt-equity ratio indicates a levered firm, which is quite preferable for a company that is stable with significant cash flow generation, but not preferable when a company is in decline. Conversely, a lower ratio indicates a firm less levered and closer to being fully equity financed. The appropriate debt to equity ratio varies by industry.

    Learn all about calculating leverage ratios step by step in CFI’s Financial Analysis Fundamentals Course!

    What is Total Debt?

    A company’s total debt is the sum of short-term debt, long-term debt, and other fixed payment obligations (such as capital leases) of a business that are incurred while under normal operating cycles. Creating a debt schedule helps split out liabilities by specific pieces.

    Not all current and non-current liabilities are considered debt.  Below are some examples of things that are and are not considered debt.

    Considered debt:

    Drawn line-of-credit

    Notes payable (maturity within a year)

    Current portion of Long-Term Debt

    Notes payable (maturity more than a year)

    Bonds payable Long-Term Debt

    Capital lease obligations

    Not considered debt:

    Accounts payable Accrued expenses Deferred revenues Dividends payable

    Benefits of a High D/E Ratio

    A high debt-equity ratio can be good because it shows that a firm can easily service its debt obligations (through cash flow) and is using the leverage to increase equity returns.

    In the example below, we see how using more debt (increasing the debt-equity ratio) increases the company’s return on equity (ROE).  By using debt instead of equity, the equity account is smaller and therefore, return on equity is higher.

    Another benefit is that typically the cost of debt is lower than the cost of equity, and therefore increasing the D/E ratio (up to a certain point) can lower a firm’s weighted average cost of capital (WACC).

    The topic above is covered in more detail in CFI’s Free Corporate Finance Course!

    Drawbacks of a High D/E Ratio

    The opposite of the above example applies if a company has a D/E ratio that’s too high.  In this case, any losses will be compounded down and the company may not be able to service its debt.

    If the debt to equity ratio gets too high, the cost of borrowing will skyrocket, as will the cost of equity, and the company’s WACC will get extremely high, driving down its share price.

    Debt to Equity Ratio Calculator

    Below is a simple example of an Excel calculator to download and see how the number works on your own.

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    Debt Equity Ratio Template

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    Video Explanation of the Debt to Equity Ratio

    Below is a short video tutorial that explains how leverage impacts a company and how to calculate the debt/equity ratio with an example.

    Video: CFI’s Financial Analysis Courses

    More Resources

    To keep learning and developing your knowledge of financial analysis, we highly recommend these additional CFI resources:

    स्रोत : corporatefinanceinstitute.com

    Debt

    The debt-to-equity (D/E) ratio indicates how much debt a company is using to finance its assets relative to the value of shareholders’ equity.

    CORPORATE FINANCE & ACCOUNTING FINANCIAL RATIOS

    Overview

    OVERVIEW OF FINANCIAL RATIOS

    Measures of a Company's Financial Health

    Financial Risk Ratios to Measure Risk

    Profitability Ratios

    Liquidity Ratios Solvency Ratios

    Solvency Ratios vs. Liquidity Ratios

    Key Ratio Multiples Approach

    PROFITABILITY RATIOS

    Return on Assets (ROA)

    Return on Equity (ROE)

    Return on Investment (ROI)

    Return on Invested Capital (ROIC)

    EBITDA Margin Net Profit Margin Operating Margin LIQUIDITY RATIOS Current Ratio Quick Ratio Cash Ratio

    Operating Cash Flow Ratio

    Receivables Turnover Ratio

    Inventory Turnover

    Working Capital Turnover Definition

    SOLVENCY RATIOS

    Debt-To-Equity Ratio

    Total-Debt-to-Total-Assets Ratio

    Interest Coverage Ratio

    Shareholder Equity Ratio

    VALUATION RATIOS

    Price-to-Earnings Ratio

    Price-to-Book Ratio

    Price-to-Sales Ratio

    Price-to-Cash Flow Ratio

    Debt-to-Equity (D/E) Ratio

    By JASON FERNANDO Updated February 19, 2022

    Reviewed by JULIUS MANSA

    Fact checked by PETE RATHBURN

    What Is the Debt-to-Equity (D/E) Ratio?

    The debt-to-equity (D/E) ratio is used to evaluate a company's financial leverage and is calculated by dividing a company’s total liabilities by its shareholder equity. The D/E ratio is an important metric used in corporate finance. It is a measure of the degree to which a company is financing its operations through debt versus wholly owned funds. More specifically, it reflects the ability of shareholder equity to cover all outstanding debts in the event of a business downturn. The debt-to-equity ratio is a particular type of gearing ratio.

    KEY TAKEAWAYS

    The debt-to-equity (D/E) ratio compares a company’s total liabilities to its shareholder equity and can be used to evaluate how much leverage a company is using.

    Higher-leverage ratios tend to indicate a company or stock with higher risk to shareholders.

    However, the D/E ratio is difficult to compare across industry groups where ideal amounts of debt will vary.

    Investors will often modify the D/E ratio to focus on long-term debt only because the risks associated with long-term liabilities are different than short-term debt and payables.

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    The Debt To Equity Ratio

    Debt-to-Equity (D/E) Ratio Formula and Calculation

    \begin{aligned} &\text{Debt/Equity} = \frac{ \text{Total Liabilities} }{ \text{Total Shareholders' Equity} } \\ \end{aligned}

    ​ Debt/Equity=

    Total Shareholders’ Equity

    Total Liabilities ​ ​

    The information needed for the D/E ratio is on a company's balance sheet. The balance sheet requires total shareholder equity to equal assets minus liabilities, which is a rearranged version of the balance sheet equation:

    \begin{aligned} &\text{Assets} = \text{Liabilities} + \text{Shareholder Equity} \\ \end{aligned}

    Assets=Liabilities+Shareholder Equity

    These balance sheet categories may contain individual accounts that would not normally be considered “debt” or “equity” in the traditional sense of a loan or the book value of an asset. Because the ratio can be distorted by retained earnings/losses, intangible assets, and pension plan adjustments, further research is usually needed to understand a company’s true leverage.

    Because of the ambiguity of some of the accounts in the primary balance sheet categories, analysts and investors will often modify the D/E ratio to be more useful and easier to compare between different stocks. Analysis of the D/E ratio can also be improved by including short-term leverage ratios, profit performance, and growth expectations.

    Melissa Ling {Copyright} Investopedia, 2019.

    How to Calculate the D/E Ratio in Excel

    Business owners use a variety of software to track D/E ratios and other financial metrics. Microsoft Excel provides a balance sheet template that automatically calculates financial ratios such as the D/E ratio and debt ratio.1 However, even the amateur trader may want to calculate a company's D/E ratio when evaluating a potential investment opportunity, and it can be calculated without the aid of templates.

    What Does the Debt-to-Equity (D/E) Ratio Tell You?

    Given that the D/E ratio measures a company’s debt relative to the value of its net assets, it is most often used to gauge the extent to which a company is taking on debt as a means of leveraging its assets. A high D/E ratio is often associated with high risk; it means that a company has been aggressive in financing its growth with debt.

    If a lot of debt is used to finance growth, a company could potentially generate more earnings than it would have without that financing. If leverage increases earnings by a greater amount than the debt’s cost (interest), then shareholders should expect to benefit. However, if the cost of debt financing outweighs the increased income generated, share values may decline. The cost of debt can vary with market conditions. Thus, unprofitable borrowing may not be apparent at first.

    स्रोत : www.investopedia.com

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