Debt to Equity : On what GEAR company is running?

Photo credit : Investopedia

For doing business, every company need Capital. Either that Capital is borrowed or owned by Promoter. On the basis of that Capital, company is operating in day to day business.

There is cost for every type of funds. For borrowed funds there is generally fixed Cost. For owned funds like Equity, there is no fixed Cost. But the claims on residual income that is Profit. Higher the Profit, higher the cost.

The use of fixed Cost Capital like debentures makes positive effect on earning of the company. That is even if company tomorrow makes anything more than expected Profit, Bank or Debentures holders will not claim on that Extra. So naturally that part is for Owners.

Higher the fixed Cost, higher the expected return on owners Fund.

But here comes the Risk. Most of the time, Banks or Debentures Trust or Holder hold the authority to shut down and liquidate your business if you don’t pay interest or EMI on time. If big part of Fixed assets are Finance from borrowed Funds, then it Means that Equity shareholders only hold claim on current asset and small amount of Fixed assets if any. Which makes return on Equity Very Low as big part of income is going to BANK. That also affect growth of the company as it is the Capital which company may use in future.

Yes there are some types of businesses which need big Capital and there Debt is important but excessive is bad.

Debt to Equity, like any other Ratio, can not tall you anything if only one company single Year is given. But cross section of time or Cross section of industry may tell you many things.

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About Ashutosh Tilak

Tracking Indian Capital Market since 2010. Finance Student, On this blog I am writing about finance and Investing. You can contact me analystashu@gmail.com or @androidashu & @InsideFinanc on twitter