debt-equity ratio

Dictionary of Accounting Terms for: debt-equity ratio
debt-equity ratio

measure used in the analysis of financial statements to show the amount of protection available to creditors. The ratio equals totalliabilitiesdivided by total stockholders’ equity; also calleddebt to net worth ratio. A high ratio usually indicates that the business has a lot of risk because it must meet principal and interest on its obligations. Potential creditors are reluctant to give financing to a company with a high debt position. However, the magnitude of debt depends on the type of business. For example, a bank has a high debt ratio but its assets are generally liquid. A utility can afford a higher ratio than a manufacturer because its earnings can be controlled by rate adjustments. Usually, book value is used to measure a firm’s debt and equity securities in calculating the ratio. Market value may be a more realistic measure, however, because it takes into account current market conditions.

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