Long Term Debt to Equity Ratio

There is no better way to ascertain the financial health of any company than studying its balance sheets. One of the important financial parameters which needs to be considered in such a study is the long term debt to equity ratio. It determines the amount of debt liabilities of any company.

Every business has a certain amount of debt which it acquires through loans, to finance its business initiatives and projects. However, every new acquired debt comes with a substantial amount of risk and financial burden, while also providing an opportunity to expand, grow and acquire new assets. As long as the borrowed money is well invested and generates sizable returns, the debt burden is not that difficult to carry, but when the profit margins dry out, debt burdens can crush and bring a company to bankruptcy.

What is Long Term Debt to Equity Ratio?

There are many debt ratios defined to evaluate the financial health of any business. In the simplest words, debt to equity ratio is the liabilities of a company, divided by its total equity holding of shareholders. When only long term debts are included as liabilities, the calculated parameter is called long term debt to equity ratio. As simple arithmetic will reveal, larger the accrued debt of a company, higher is the debt to equity ratio going to be. All debts come at a cost, which is the interest rate charged on the principal amount of borrowing and it eats into the profit margins of a company. So unless a fresh cash infusion through a mortgage loan is going to add to the profit margins of a company, it's a bad business decision overall. Still, risks need to be taken and certain investments take time to bear fruit. In such cases, a company may risk a high debt to equity ratio, with the hope of making profits in the long term.

Debt to Equity Ratio Formula

To be able to calculate the debt to equity ratio, you need to have access to some crucial financial data, that includes the long term debts of the company, along with the valuation of the shareholder's equity holding. The formula is as follows:

Long Term Debt to Equity Ratio = (Total Long Term Debts / Shareholder's Equity Value )

As mentioned before, you only consider long terms debts like mortgage loans on land and other assets while making this calculation. A low ratio value means that the company is in relatively good shape, with assets that can keep it buoyant with manageable debt. A very high ratio value means that the company has borrowed heavily and is in a risky financial position, unless bailed out by good performance overall and good quarterly profit margins.

A high long term debt to equity ratio value is bad news for a company as it cuts into the profits and weighs heavily on the overall finances. On the other hand, a low debt to equity ratio indicates that the company is in overall good health and is a comparatively better stock investment option, as debts are not cutting into its profits to a large extent. Hope this article has cleared out most of your doubts regarding what is debt to equity ratio and how it helps you gauge a company's financial health.