“What Do Financial Ratios Really Mean? (Part 2)” The Beal Business Advisor

Oct 4, 2011 | Corporate Member News

Last month, we discussed some common financial ratios used in financial analyses. Today we will look at the “debt-to-equity ratio.” 

The debt-to-equity ratio is calculated by dividing total liabilities by stockholders’ equity (sometimes only interest bearing debt is used). The ratio demonstrates the amount a company is leveraged, meaning how much the company funds operations through debt financing versus equity financing.   

A simple comparison is mortgage financing.  Typically, banks lend you up to 75% of the value of a house purchase (up to 90-95% with CMHC insurance).  Using the more normal 75% would result in a debt to equity ratio of 3:1 ($3 of debt for $1 of equity).  

For a business, a debt-to-equity ratio under one-to-one indicates there is less debt than equity, which tends to make the business more stable, all other things being equal. A high debt/equity ratio generally means that a company is aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense.   

It also results in a higher level of risk, because the cost of the debt may be larger than the return that company generates through business activities. 

The right debt/equity ratio also depends on the industry.  Capital-intensive industries often have higher debt whereas service industries often have lower debt.  It is key to compare your company’s ratio to an industry benchmark before interpreting the meaning behind your score. 

Improving your debt-to-equity ratio often means restructuring your financing through increasing equity or decreasing the level of debt. 

For more information on understanding your financial position, contact us at 204-478-7266 x110. 

This article originally appeared in the October 2011 edition of The Beal Business Advisor. The issue also included:       

  • Buying a Business 
  • The Business Sales Process 
  • Quote of the Month 
  • Upcoming Seminars
  • Businesses for Sale 

Check it out here

About Beal Consultants, Business Growth Professionals

Focused Business Advisors
Beal Consultants helps people buy, sell, value, improve, and start businesses. We deliver value-added services in the following areas:

Grow Your Business
We can help make your business grow profitably using proven success strategies, step-by-step guidelines and an abundance of insight from our experience in working across a wide variety of industries.

Insightful Diagnostic Report

Are you ‘too close’ to your business? Are you working too hard in your business you have no time to work on it? Do you need a second perspective, a fresh pair of eyes?

Using a proven methodology, we can come in, interview you and your key staff, review your financial results against industry benchmarks, and make concrete recommendations on how to improve your business.

Improving your business means more profit for you, more free time and, eventually, more value when you exit. Call today for a free, no risk initial consultation.

Strategic Planning

Strategy planning is NOT about creating 50-page documents that are never referred to again. Strategic (and business) planning is all about understanding how your business can grow and thrive in a challenging, competitive business environment.

You are competing against many competitors, not just your direct competitors, but all your indirect competitors as well. You are vying for attention in an increasingly complex and crowded marketplace. You need to clearly understand – and you need to communicate to your clients – your key value proposition – why should they do business with you? Understanding your value proposition is key to differentiating yourself in today’s marketplace, and is key to having a sustainable competitive advantage. Your business strategy and business success relies on having a crystal clear understanding of your unique competitive advantage.

Find out more here.

About Beal Consultants – Business Brokers

Focused Business Advisors

Beal Consultants – Business Brokers helps people buy and sell businesses. We deliver value-added services in the following areas:

Buy a Business
We provide counsel, guidance and support throughout all steps of buying a business including: Search, Screening, Valuation, Negotiation, Due Diligence, Financing and Agreement Structuring.

Sell Your Business
We provide counsel, guidance and support throughout the process of selling a business. Some of the advantages of hiring an intermediary to sell your business include: confidentiality, creating and executing the marketing package, negotiation, and buyer screening.

Succession Planning/Exit Strategy
Looking to retire? Great! Is your business ready for you to retire? Can you afford to retire? Do you know how to minimize your tax burden when you are looking to sell or pass your business on to your children? We can help you understand the options that are available to you. Think it’s too early? The earlier you start, the more your business can be worth, and the more options you have to minimize taxes. If you’re thinking of getting out within five or less years, start planning today!

Business Valuation
Need to know what your business is worth? We help you determine the value of it and understand the key drivers of that value, so you can know how to improve it.

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