Debt-Equity Ratio: The debt-equity ratio is determined to ascertain the soundness of the long-term financial position of the company. It is also known as “External – Internal” equity ratio.



Total long-term debt

Debt – Equity Ratio = ——————————————

Shareholder’s funds


Significance: The ratio indicates the preparation of owners’ stake in the business. Excessive liabilities tend to cause insolvency. The ratio indicates the extent to which the firm depends upon outsiders for its existence. The ratio provides a margin of safety to the creditors. It tells the owners the extent to which they can gain the benefits or maintain control with a limited investment.


(c) Proprietary ratio : It is a variant of debt-equity ratio. It establishes relationship between the proprietor’s funds & the total tangible assets. It may be expressed as:


Shareholder’s funds

= ——————————–

Total tangible assets


Significance: This ratio focuses the attention on the general financial strength of the business enterprise. The ratio is of particular importance to the creditors who can find out the proportion of shareholders funds in the total assets employed in the business. A high proprietary ratio will indicate a relatively little danger to the creditor’s etc., in the event of forced reorganization or winding up of the company. A low proprietary ratio indicates greater risk to the creditors since in the event of losses a part of their money may be lost besides loss to the properties of the business. The higher the rate, the better it is. A ratio below 50 percent may be alarming for the creditors since they may have to lose heavily in the event of company’s liquidation on account of heavy losses.


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