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Why D/E ratio matters
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How to calculate D/E ratio
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How to benchmark D/E ratio
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How to reduce D/E ratio
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How to increase D/E ratio
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Here’s what else to consider
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Debt-to-equity ratio (D/E) is a measure of how much a company relies on borrowed money to finance its operations and growth. A high D/E ratio means that the company has more debt than equity, which can increase its risk of default and limit its ability to access more credit. A low D/E ratio means that the company has more equity than debt, which can reduce its cost of capital and enhance its financial flexibility. Therefore, improving your company's D/E ratio can be a strategic goal for enhancing its financial performance and value.
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- Hanan Hasbullah Senior Accountant @ Coreo Real Estate | Head of Finance 2
1 Why D/E ratio matters
Your company's D/E ratio can affect its profitability, liquidity, solvency, and valuation. A high D/E ratio can lower your company's profitability by increasing its interest expenses and tax burden. It can also reduce your company's liquidity by limiting its cash flow and working capital. Moreover, a high D/E ratio can impair your company's solvency by increasing its leverage and financial distress. Finally, a high D/E ratio can lower your company's valuation by increasing its cost of equity and discount rate. Therefore, improving your company's D/E ratio can help you improve these key financial indicators and attract more investors and lenders.
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- Hanan Hasbullah Senior Accountant @ Coreo Real Estate | Head of Finance
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The D/E ratio, crucial in accounting, measures a company's financial health by assessing its debt and equity balance. It influences investor confidence, indicates risk, and guides strategic decisions. For accountants, managing this ratio is vital for sound financial analysis and decision-making in corporate finance.
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2 How to calculate D/E ratio
Your company's D/E ratio is calculated by dividing its total debt by its total equity. Total debt includes both short-term and long-term liabilities, such as bank loans, bonds, leases, and accounts payable. Total equity includes both common and preferred stock, as well as retained earnings and other reserves. For example, if your company has $100 million of total debt and $50 million of total equity, its D/E ratio is 2. This means that for every $1 of equity, your company has $2 of debt.
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3 How to benchmark D/E ratio
Your company's D/E ratio can vary depending on its industry, size, stage, and strategy. Therefore, to assess whether your company's D/E ratio is optimal or not, you need to compare it with some benchmarks. One benchmark is the industry average, which reflects the typical capital structure and risk profile of your company's peers. Another benchmark is the target D/E ratio, which reflects your company's desired level of leverage and return. You can use various methods to determine your company's target D/E ratio, such as the trade-off theory, the pecking order theory, or the market timing theory.
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4 How to reduce D/E ratio
If your company's D/E ratio is higher than its benchmarks, you may want to reduce it to improve your company's financial health and attractiveness. There are two main ways to reduce your company's D/E ratio: reducing your debt or increasing your equity. Reducing your debt can involve repaying your existing loans, refinancing your debt at lower interest rates, or restructuring your debt to extend its maturity or reduce its principal. Increasing your equity can involve issuing new shares, retaining more earnings, or selling some assets and reinvesting the proceeds.
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- Hanan Hasbullah Senior Accountant @ Coreo Real Estate | Head of Finance
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Reducing the D/E ratio is key for financial health. Prioritize debt repayment, optimize working capital, and explore equity infusion. Negotiate favorable terms with creditors and diversify funding sources. Effective risk management is crucial.
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5 How to increase D/E ratio
If your company's D/E ratio is lower than its benchmarks, you may want to increase it to take advantage of the benefits of leverage and growth. There are two main ways to increase your company's D/E ratio: increasing your debt or reducing your equity. Increasing your debt can involve borrowing more money, issuing more bonds, or leasing more assets. Reducing your equity can involve buying back your shares, paying more dividends, or distributing some assets to shareholders.
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- Hanan Hasbullah Senior Accountant @ Coreo Real Estate | Head of Finance
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Increasing the D/E ratio involves leveraging debt strategically. Consider issuing bonds, securing loans, or opting for share buybacks to boost debt. Retaining less profit and exploring mergers/acquisitions can also contribute. Evaluate the impact on financial health and risk.
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6 Here’s what else to consider
This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?
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