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The debt-equity ratio is determined to ascertain thesoundness of
the long-term financial policies of thecompany. It is also called
as External Internalequity ratio.
Debt-Equity ratio indicates the relationship betweenthe external
equities or outsiders funds and theinternal equities or
shareholders funds.
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Debt-equity ratio indicates the proportionate ofowners stake in
the business. Excessive liabilitiestend to cause insolvency. The
ratio indicates theextent to which the firm depends upon
outsidersfor its existence. The ratio provides a margin ofsafety to
the creditors. It tells the owners the
extend to which they can gain the benefits ormaintain control
with a limited investment.
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1. Debt Equity Ratio = External Equities / Internal
Equities
2.Total Long Term Debts / Total Long-Term Funds.
3.Shareholders funds/ Total Long Term Funds
4.Total Long Term Debts / Shareholders Funds
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Share holders funds includes., equity sharecapital, preference
share capital, capital reserves,revenue reserves, and reserves
representingaccumulated profits and surpluses like reservesfor
contingencies, sinking funds, etc. Theaccumulated losses and
deferred expenses, ifany, should be deducted from the total to
findout shareholder's funds.
Total long-term funds includes., share holdersfund, mortgage
loan & debentures, and futuretaxation.
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ABC Ltd., external equity is 5,00,000 and internalequity is
8,00,000
Debt-equity ratio= external equity/ internalequity
=5,00,000/ 8,00,000
=0.63
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From the following figures calculate debt-equity ratio:
Preference share capital-1,00,000 Equity share capital -
2,00,000 Capital reserve- 50,000 Profit and loss account-50,000 6%
mortgage debentures-1,00,000
Unsecured loans-50,000 Creditors-40,000
Bills payable-20,000 Provision for taxation-10,000 Provision for
dividends-20,000
Required: Calculate debt -equity ratio.
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Debt Equity Ratio=Share holders funds/ Total
long-term funds
=preference share capital + equity share capital+capital
reserves + Mortgage Debentures Loss
account / Share holders fund + unsecured loans +mortgage
debentures
= 1,00,000+2,00,000+50,000+1,00,000-50,000 /
4,00,000 + 50,000 + 1,00,000=4,50,000-50,000/ 5,50,000
=4,00,000/5,50,000=0.73
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Proprietary Ratio (also known as Equity Ratio or theNet Worth to
Total Assets Ratio) it is the proportion ofshareholders' funds to
total assets. A high ratio will
indicate that the firm has sufficient amount of equityto support
the functions of the business.
Proprietary Ratio = Shareholders funds / Total
Assets
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Shareholder's funds include sharecapital plus all reserves and
surplusesitems.
Total assetsinclude all assets,.
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This ratio throws light on the generalfinancial strength of the
company. It isalso regarded as a test of the soundness
of the capital structure. Higher the ratioor the share of
shareholders in the totalcapital of the company, better is the
long-term solvency position of thecompany. A low proprietary
ratio willinclude greater risk to the creditors.
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Preference share capital = 1,00,000Equity share capital =
2,00,000Reserves & Surplus = 50,000Debentures =
1,00,000Creditors = 50,000
--------------5,00,000--------------
Fixed assets = 2,00,000
Current assets = 1,00,000Goodwill = 50,000Investments =
1,50,000
-------------5,00,000
-------------
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Equity Ratio = Shareholders funds / Total Assets
pref.share + Eq.share + R & S Goodwill
= -------------------------------------------------
Total assets
1,00,000 + 2,00,000 + 50,000 50,000
= ------------------------------------------------
5,00,000
= 3,00,000 /5,00,000
= 0.6 (or) 60%
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