Guide To D/E Ratio: Assess Liquidity & Solvency To Identify Your Financial Risk

by PRC Agency PR

To run a successful business, you need to have a clear picture of how well your company is performing. Knowledge is power, allowing you to make more informed decisions about the future of your business.

So how do you achieve this clear picture? Whilst there are many metrics you can use to determine your financial health, Online Accounting Tips recommends debt-to-equity ratio as one of the most useful of them all!

What is D/E Ratio?

The experts at Online Accounting Tips provide a thorough overview of the debt-to-equity ratio, a figure showing how much debt a company has compared to its assets. This ratio is determined by dividing your company’s total debt by total shareholder equity. For example, if your company has $400,000 in total debt and $1 million in shareholder’s equity, then its debt-to-equity- ratio would be 0.4.

Go to https://onlineaccountingtips.com/debt-to-equity-ratio-assessing-a-companys-financial-leverage/ to find out more.

As explained in the guide, a higher D/E ratio indicates that your company has taken on too much risk and may not be in a good financial position to cover its debts. On the other hand, a low D/E ratio suggests that your company has not had to rely on borrowing to finance its operations and is, therefore, in a stronger financial position. In short, you are aiming for a low D/E, but just knowing the figure will help you to make more informed business decisions in the future.

“A low debt-to-equity ratio indicates that a company has less reliance on borrowed funds compared to its equity,” explains the guide. “This means that the company is not heavily burdened by debt obligations, which can be a positive sign of financial stability. It also suggests that the company has enough cash flow to cover its debts and may have lower interest expenses, impacting profitability positively.”

The guide moves on to explain the terms ‘liquidity’ and solvency’ in assessing your company's financial health. Liquidity refers to a company’s ability to meet short-term obligations, turning assets into ready cash, whereas solvency assesses a company’s ability to meet long-term debts and financial obligations. “An optimal debt-to-equity ratio can indicate efficient liquidity management, while high ratios may suggest excessive reliance on borrowed funds or a need for debt restructuring,’ states the guide.

What Can Affect D/E Ratio?

The experts at Online Accounting Tips delve into the factors affecting debt-to-equity ratio, listing interest rates as a common contributing factor. “When interest rates are low, companies tend to borrow more, resulting in a higher debt-to-equity ratio. On the other hand, when interest rates are high, companies may opt for equity financing instead of borrowing, leading to a lower debt-to-equity ratio.”

In addition to fluctuating interest rates, business cycles can also have a major influence on your D/E ratios, explains the guide. For example, during periods of economic downturn or recession, your company may experience problems with cash flow, forcing you to take on additional debt to sustain business.

In business, debt isn't all bad and can actually be an efficient way to grow your business. However, it is important to keep track of your D/E ratio, to ensure balanced financial health. With this knowledge, you can avoid risk and continue your journey toward success.

To read more on the benefits of D/E ratios, please visit https://onlineaccountingtips.com/

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