Week 2 Discussion 1: Financial Ratios

Select one financial ratio and discuss how it is calculated, as well as its purpose and who might be interested in the information it provides.

Wnd discuss how it is calculateek 2 Discussion 1: Financial Ratios Select one financial ratio aed, as well as its purpose and who might be interested in the information it provides-Sample Solution

Debt/Equity Ratio

The debt/equity is the leverage ratio companies, or businesses use to evaluate their leverage by determining whether they borrow more funds than they can pay back (Birt, 2020). The leverage ratio compares how a company finances its operations through debt and shareholder equity. The debts include deferred taxes, business loans, mortgages, and accrued expenses, while the shareholder’s equity consists of retained earnings, treasury stock, and outstanding shares. According to Birt (2020), companies calculate it by dividing their liabilities by the total shareholder equity.(Financial Ratios Essay Example)

Debt/Equity = Total Liabilities/ Total Shareholder’s Equity

Birt (2020) observes that the information obtained from the debt-to-equity ratio is vital to investors, stakeholders, and lenders. They use it in risk analysis of a company, such that a lower debt-equity ratio is appealing to investors, stakeholders, and lenders, making it easy for the business to qualify for loans and attract investments. This increases the protection of the lender’s money. Additionally, it determines whether a company is plunging into bad debt (Birt, 2020). It draws a line between bad and good debt. A higher debt-to-equity ratio indicates that a company/ individual uses more debts than shareholder equity/personal assets to finance its operations. A ratio below 1.0 is good, while above 2.0 is bad (Birt, 2020).(Financial Ratios Essay Example)

Moreover, lenders or stakeholders use it during the financial analysis of a company. They use the data to determine a company’s capacity to repay its debts. Birt (2020) explains that analyzing the data is necessary for companies performing work and sending invoices after completing the projects since it can help prove that a company is more or less at risk depending on what the customers owe it. Lastly, the ratio to determine shareholder earnings (Birt, 2020). A higher debt-to-equity ratio reduces profits, forcing companies to pay shareholders fewer dividends since much of the profit is used in paying debts.(Financial Ratios Essay Example)

Reference

Birt, J. (2020). Accounting: Business reporting for decision making. (7th ed., pp. 283-311). Milton, QLD: John Wiley and Sons Australia, Ltd