Debt
/ Equity Ratio
| Total Debt-Equity
ratio = |
Debt |
|
Equity |
This ratio considers the total
borrowed funds including interest and non interest-bearing
debt. But we can
take into consideration only
the financial debt, that is interest-bearing
debt.
Debt-Equity
ratio = |
Interest-bearing
Debt |
|
Equity |
Determining the appropriate level
of debt of a company is a major responsability
of corporate financial officers and one of the
most difficult problems in finance. It varies
very much according to countries. Within one
country, it varies also very much according
to companies.
The name
of the game here is Risk !
The
business risk : risk associated
with the nature of the business in which the
firm is operating.
The
financial risk : risk created by
the way the firm finances its assets.
Basic rule
If a company is operating in a
high business risk
(highly competitive environment, low barriers
of entry in the industry, high potential subsitution
of products, etc), il should not add a high
financial risk to it in order to maintain the
overall risk in acceptable limits. In that case,
the ratio D/E should be rather low. This is
the reason why some industries today (Ford,
High-Tech sector) have a very conservative financial
policy.
Conversely, firms having a low
business risk (monopols, low substitution
of products, high barriers of entry in the industry...etc)
can safely take more financial leverage and
sustain more debt in their financial structures.
This explains why in recent years, we have experienced
most of the LBO's (Leverage-Buy-Out), that is
acquisitions of firms with a very high D/E ratio
(Energy industries, Food and Drinks Industry,
Cigarette business...)
|
2017 |
2018 |
2019 |
2020 |
2021 |
2022 |
2023 |
Net Debt-to-Equity (gearing) |
5 % |
30 % |
30 % |
18 % |
6 % |
14.1 % |
8.2 % |
|
Sources :
Interpreting
and using financial statements, 1999,
Marc Bertonèche, Ph. D. in Finance from
the Northwestern University, Professor at the
Bordeaux University and at Sciences-PO Paris,
Visiting Professor at Harvard Business School
and Oxford University.
© ECOFINE.COM, Bernard Jaquier, Professor Emeritus & Dr Honoris Causa, Lausanne, SWITZERLAND, 2024
