Debt to equity ratio The debt-to-equity ratio measures the extent of a company’s debt exposure. This is a useful ratio because it indicates where a company stands in relation to its creditors. Generally speaking the higher the figure the greater the risk the company faces in repaying its debtors. Although there is no hard-and-fast rule about the safest level of debt a company should have in order to stay out of trouble, we believe that 80% gearing or below (depending on the sector) is a useful guide to judge whether a company is being financially responsible or not. There are a few ways of calculating this ratio but this simple calculation is a good indicator of a company’s debt position. We prefer to use only interest-bearing liabilities such as bank loans and other borrowings, minus the company’s cash because these are the most important liabilities. Now here’s a formula: Debt-to-equity ratio = (borrowings - cash/shareholders’ equity) x 100 One thing to keep in mind is that this figure doesn’t tell you the full story. A company with a steady income stream and continued profits coupled with high gearing such as Hills Motorway is often safer than a company with less debt but more volatile earnings such as NRMA.
Posted on: Mon, 17 Feb 2014 17:44:24 +0000