The debt-equity ratio is determined to ascertain the soundness of the long-term financial policies of the company.

It is also called as External Internal equity ratio. Debt-Equity ratio indicates the relationship between the external equities or outsiders funds and the internal equities or shareholders funds.

Debt-equity ratio indicates the proportionate of owners stake in the business. Excessive liabilities tend to cause insolvency. The ratio indicates the extent to which the firm depends upon outsiders for its existence. The ratio provides a margin of safety to the creditors. It tells the owners the extend to which they can gain the benefits or maintain control with a limited investment.

 1. Debt Equity Ratio = External Equities / Internal

Equities
2.Total Long Term Debts / Total Long-Term Funds. 3.Shareholders funds/ Total Long Term Funds 4.Total Long Term Debts / Shareholders Funds

Share holders funds includes., equity share capital, preference share capital, capital reserves, revenue reserves, and reserves representing accumulated profits and surpluses like reserves for contingencies, sinking funds, etc. The accumulated losses and deferred expenses, if any, should be deducted from the total to find out shareholder's funds.
Total long-term funds includes., share holders fund, mortgage loan & debentures, and future taxation.

ABC Ltd., external equity is 5,00,000 and internal equity is 8,00,000 Debt-equity ratio= external equity / internal equity =5,00,000/ 8,00,000 =0.63

From the following figures calculate debt-equity ratio:

Preference share capital-1,00,000 Equity share capital - 2,00,000 Capital reserve- 50,000 Profit and loss account-50,000 6% mortgage debentures-1,00,000 Unsecured loans-50,000 Creditors-40,000 Bills payable-20,000 Provision for taxation-10,000 Provision for dividends-20,000

Required: Calculate debt -equity ratio.

Debt Equity Ratio=Share holders funds/ Total long-term funds =preference share capital + equity share capital+ capital reserves + Mortgage Debentures Loss account / Share holders fund + unsecured loans + mortgage debentures = 1,00,000+2,00,000+50,000+1,00,000-50,000 / 4,00,000 + 50,000 + 1,00,000 =4,50,000-50,000/ 5,50,000 =4,00,000/5,50,000 =0.73

Proprietary Ratio (also known as Equity Ratio or the Net Worth to Total Assets Ratio) it is the proportion of shareholders' funds to total assets. A high ratio will indicate that the firm has sufficient amount of equity to support the functions of the business.

Proprietary Ratio = Shareholders funds / Total Assets

Shareholder's funds include share

capital plus all reserves and surpluses items.

Total assets include all assets,.

This ratio throws light on the general financial strength of the company. It is also regarded as a test of the soundness of the capital structure. Higher the ratio or the share of shareholders in the total capital of the company, better is the long-term solvency position of the company. A low proprietary ratio will include greater risk to the creditors.

Preference share capital Equity share capital Reserves & Surplus Debentures Creditors

= 1,00,000 = 2,00,000 = 50,000 = 1,00,000 = 50,000 -------------5,00,000 -------------= 2,00,000 = 1,00,000 = 50,000 = 1,50,000 ------------5,00,000 -------------

Fixed assets Current assets Goodwill Investments

Equity Ratio = Shareholders funds / Total Assets pref.share + Eq.share + R & S Goodwill = ------------------------------------------------Total assets 1,00,000 + 2,00,000 + 50,000 50,000 = -----------------------------------------------5,00,000 = 3,00,000 / 5,00,000 = 0.6 (or) 60%