Debt to equity ratio (solvency) HELP MEEEEEEEEEEEEEE (1 Viewer)

Power Rangers

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In my textbook, the ratio is total liabilities (Debt): total equity (assets)

but in another book, it's written as total debt/owner's equity x100



What is this? WHICH ONE DO I USE?
They're COMPLETELY different. One is just a measure of the capability of a business to pay off their debt, and the other is the level of debt in comparison with the contribution of the owners/shareholders.

ALSO. The textbook has it in ratio form, and the other book has it as a percentage.


please respond (lol)
 

seremify007

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Sorry I may be missing something but can you clarify your question? I'm a tad confused what you're asking.
 

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Which formula do I use?


total debt/owner's equity x100 OR total liabilities/total equity x100
 

seremify007

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How are the two different? Debt is always a liability, and liabilities are all a form of debt whether in some way whether it be financial or non-financial. That being said, some business analysts would only use genuine interest-bearing debt as a liability for this calculation in determining the ratio of debt to equity as funding sources.

As for your original post regarding ability to repay debt- neither of those ratios are really a solvency indicator. The debt to equity ratio merely shows how much of a company's assets are funded by debt/borrowings (i.e. definite payment required) vs. equity (i.e. where if there is residual profit/interest left over, then these guys get paid). Ultimately it's a measure of leverage (i.e debt funding vs. equity funding), and really is just indicative of the who will get paid before you if you're a shareholder or how much risk you have taken on since equity interests are the lowest on the distribution/payment hierarchy.

ps. I'd usually use percentage.
 

Power Rangers

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How are the two different? Debt is always a liability, and liabilities are all a form of debt whether in some way whether it be financial or non-financial. That being said, some business analysts would only use genuine interest-bearing debt as a liability for this calculation in determining the ratio of debt to equity as funding sources.

As for your original post regarding ability to repay debt- neither of those ratios are really a solvency indicator. The debt to equity ratio merely shows how much of a company's assets are funded by debt/borrowings (i.e. definite payment required) vs. equity (i.e. where if there is residual profit/interest left over, then these guys get paid). Ultimately it's a measure of leverage (i.e debt funding vs. equity funding), and really is just indicative of the who will get paid before you if you're a shareholder or how much risk you have taken on since equity interests are the lowest on the distribution/payment hierarchy.

ps. I'd usually use percentage.
Aren't they different because owner's equity is how much they've actually put into the business, whereas total equity includes stock and profit etc etc?


idk :(
 

seremify007

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Aren't they different because owner's equity is how much they've actually put into the business, whereas total equity includes stock and profit etc etc?


idk :(
Sorry missed that in your post above but either way, I'd use total equity. I see the point of differentiation you are trying to make but at the end of the day, equity reflects the residual interest and thus includes both initial capital contribution as well as any retained earnings (since these are essentially owned by the people who contributed capital).
 

Power Rangers

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Sorry missed that in your post above but either way, I'd use total equity. I see the point of differentiation you are trying to make but at the end of the day, equity reflects the residual interest and thus includes both initial capital contribution as well as any retained earnings (since these are essentially owned by the people who contributed capital).
I was pretty sure it was total equity as well, I was just checking.

Also to your post about it being a poor measure of solvency, according to my textbook, it indicates the ability to meet long term financial obligations through comparing how much you're able to pay, and how much you owe. I'm just doing things by the textbook :p

I'm studying the ratios because our task is to use cash flow sheets and income sheets to compare the performance of a made up business with a competitor and the industry average, as well as ways to improve the overall performance. So yeah, i'm just fiddling with how everything works on these sheets. It's not too hard of a task given you know how to read the balance sheet and stuff :D
 
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seremify007

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Also to your post about it being a poor measure of solvency, according to my textbook, it indicates the ability to meet long term financial obligations through comparing how much you're able to pay, and how much you owe. Just doing things by the textbook, man :p
Still doesn't make sense to me. I guess it might be getting back to the whole residual interest aspect whereby if everything went bad and they had to realise assets, any shortfalls would be borne by the equity holders and this ratio essentially shows how much buffer there is before it eats into liability holders interests. If you can be bothered I would be keen to see a photo of what the book actually says.

Ps. Its interesting that anyone in the modern business age would also be so heavily focussed on long term liabilities- its the short term ones which kill companies. Even listed ones.




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seremify007

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Ps your assignment sounds quite interesting lol. Also not too far from what people actually do in business whether it be a finance or accounting role.


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Syllabus says:
– gearing – debt to equity ratio (total liabilities ÷ total equity)
 

Power Rangers

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Still doesn't make sense to me. I guess it might be getting back to the whole residual interest aspect whereby if everything went bad and they had to realise assets, any shortfalls would be borne by the equity holders and this ratio essentially shows how much buffer there is before it eats into liability holders interests. If you can be bothered I would be keen to see a photo of what the book actually says.

Ps. Its interesting that anyone in the modern business age would also be so heavily focussed on long term liabilities- its the short term ones which kill companies. Even listed ones.
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Yeah, the textbook said the same thing :p
Something about most businesses failing because they were illiquid despite being profitable, rather than actually making losses.

This is what the textbook says:


and this is a photocopy of another textbook that my teacher gave us that had the different formula:



Ps your assignment sounds quite interesting lol. Also not too far from what people actually do in business whether it be a finance or accounting role.


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tbh, I really like this finance topic. I actually find it pretty interesting. The rest of business studies i.e. human resources, marketing and operations I have no interest in at all.

What's the job in business that involves actually going through these and coming up with suggestions to improve performance?

I was interested in auditing (and yes, I know that auditing does not involve coming up with suggestions to improve performance incase you think I thought it did from the line above), but people tell me it entailed long hours and low pay, so i've kind of looked at other things.
 
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seremify007

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Yeah, the textbook said the same thing :p
Something about most businesses failing because they were illiquid despite being profitable, rather than actually making losses.

This is what the textbook says:


and this is a photocopy of another textbook that my teacher gave us that had the different formula:
The second one with the fugly diagram I feel is more accurate. I don't know anyone who uses debt to equity as their measure of solvency. The debt to equity ratio is more of a risk gauge which merely shows what the debt level is relative to the equity level, and I suppose indirectly shows how much buffer the business has in the event of a downturn (since debt repayments- i.e. interest) are required to be made regardless whereas equity and equity distributions are not mandatory.

tbh, I really like this finance topic. I actually find it pretty interesting. The rest of business studies i.e. human resources, marketing and operations I have no interest in at all.

What's the job in business that involves actually going through these and coming up with suggestions to improve performance?
Management consulting- but it's both a) damn competitive at grad level; and b) see a! They don't tend to offer that many positions because realistically if you haven't seen much of the world yet in terms of working, how can you add value or tell a company which has been doing the same thing for fifty years exactly how to improve?

Another role is financial analyst whereby you use ratios and various other data to determine whether something is performing as well as it should or shouldn't, and help management make decisions as to what to do- e.g. should we keep producing XYZ, should we keep holding onto this division or should we sell it, etc. This role kindof crosses over a bit with management accounting depending on where the focus or purpose lies (i.e. is it in the ratios/data analysis, or is it is in analysing data for supporting management decisions).

Alternatively, if you work in a bank, equities analyst. It involves researching all the various ratios as well as staying on top of qualitative factors (e.g. news events) to determine the value of a company and whether or not to invest.

I was interested in auditing (and yes, I know that auditing does not involve coming up with suggestions to improve performance incase you think I thought it did from the line above), but people tell me it entailed long hours and low pay, so i've kind of looked at other things.
LOL all the good jobs entail long hours and low pay, at least in the first few years- especially if you do a traineeship/cadetship. But you don't do those for the money, you do it for the opportunities you get later on in terms of great job offers elsewhere or just faster promotion. If you're really keen to talk salary ranges PM me.
 

Power Rangers

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The second one with the fugly diagram I feel is more accurate. I don't know anyone who uses debt to equity as their measure of solvency. The debt to equity ratio is more of a risk gauge which merely shows what the debt level is relative to the equity level, and I suppose indirectly shows how much buffer the business has in the event of a downturn (since debt repayments- i.e. interest) are required to be made regardless whereas equity and equity distributions are not mandatory.
The second one is more accurate? But what about the formula? The second one is just measuring how much debt a business has compared to what has been invested by the owners as opposed to the actual debt to total equity?

Management consulting- but it's both a) damn competitive at grad level; and b) see a! They don't tend to offer that many positions because realistically if you haven't seen much of the world yet in terms of working, how can you add value or tell a company which has been doing the same thing for fifty years exactly how to improve?

Another role is financial analyst whereby you use ratios and various other data to determine whether something is performing as well as it should or shouldn't, and help management make decisions as to what to do- e.g. should we keep producing XYZ, should we keep holding onto this division or should we sell it, etc. This role kindof crosses over a bit with management accounting depending on where the focus or purpose lies (i.e. is it in the ratios/data analysis, or is it is in analysing data for supporting management decisions).

Alternatively, if you work in a bank, equities analyst. It involves researching all the various ratios as well as staying on top of qualitative factors (e.g. news events) to determine the value of a company and whether or not to invest.

That's a really good point, I didn't think of it like that. To be honest, I wouldn't have thought management consulting would be that competitive because I didn't think that anyone would really enjoy writing these reports and thinking of ways to improve performance. It wont even be an easy job, because there would be so many things that you'd need to factor in. Improving performance in one area might affect another or something :/

Note to self: See the world :p


LOL all the good jobs entail long hours and low pay, at least in the first few years- especially if you do a traineeship/cadetship. But you don't do those for the money, you do it for the opportunities you get later on in terms of great job offers elsewhere or just faster promotion. If you're really keen to talk salary ranges PM me.
It's not really the money aspect of it though. I don't have any objection to starting at the bottom and working my way up the pyramid, but it's also that i've been told that there aren't that many jobs either and it was quite competitive.


So by my logic, racking up HECS to study something that will likely result in low pay and long hours, if I even get a job (because there are so few) probably isn't the wisest option. I know you have to start at the bottom, but what if you can't be the 1% who gets a better position and you're stuck earning 60k a year barely making ends meet? :p

I think what i'm looking for is job security and decent pay. It isn't my life objective to get rich and work as little as I can, it's just me not wanting to have a huge HECS debt and not being able to find employment because I chose a career path that is already saturated i.e. Pharmacy
 

seremify007

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Second one has more accurate description of what the ratio tells you.


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my exam is today :(

and i'm just checking, but is this right?
total assets= owner's equity+ current assets+ non-current assets
total liabilities= current+non-current liabilities
 

seremify007

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my exam is today :(

and i'm just checking, but is this right?
total assets= owner's equity+ current assets+ non-current assets
total liabilities= current+non-current liabilities
Total assets = current assets + non-current assets = liabilities + equity

Good luck!
 

seremify007

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That's a really good point, I didn't think of it like that. To be honest, I wouldn't have thought management consulting would be that competitive because I didn't think that anyone would really enjoy writing these reports and thinking of ways to improve performance. It wont even be an easy job, because there would be so many things that you'd need to factor in. Improving performance in one area might affect another or something :/

Note to self: See the world :p
MC is right up there with IB as it pays reasonably well and is very intellectually stimulating. Lots of competition for not many jobs compared to say accounting or the other less glamorous roles in finance.

It's not really the money aspect of it though. I don't have any objection to starting at the bottom and working my way up the pyramid, but it's also that i've been told that there aren't that many jobs either and it was quite competitive.

So by my logic, racking up HECS to study something that will likely result in low pay and long hours, if I even get a job (because there are so few) probably isn't the wisest option. I know you have to start at the bottom, but what if you can't be the 1% who gets a better position and you're stuck earning 60k a year barely making ends meet? :p
You realise that $60k is like the average income right which isn't bad for a fresh graduate. AFAIK graduate jobs are in the high $40's to low $70's for most roles (outside of IB/trading/equities which are circa $100k... if you can find one). Realistically if you are joining a graduate program, you do so because it's something which will give you progression and development opportunities rather than outright salary.

I think what i'm looking for is job security and decent pay. It isn't my life objective to get rich and work as little as I can, it's just me not wanting to have a huge HECS debt and not being able to find employment because I chose a career path that is already saturated i.e. Pharmacy
I'll put it in perspective then- I'm 24, I have no HECS debt as I repaid it in full, and I bought myself a decent car without using any financing/loans. I'd say commerce has better prospects than pharmacy by a long shot but like you said, there are risks with any industry and commerce is one of those areas which is really not a production business and hence is dependent on other industries to have prosper.
 
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one is expressed as a decimal and the other expresses it as a percentage. How hard is it?
 

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