Essay about Financial Ratios Comparison
2.9.1 Debt Ratio
Debt ratio measures the percentage of total assets that are financed by debts. Creditors prefer lower debt ratio as the lower the debt ratio, the higher the protection for their losses upon liquidation. Unlike the preference of creditors for a lower debt ratio, the management might choose a higher leverage to increase earnings. This is because they do not like to issue new equity as they fear the degree of control in the company will reduce. The higher the debt ratio, the higher the percentage of assets being funded by debts
2.9.2 Debt-equity Ratio
Debt equity ratio measures the total long-term debts for each ringgit of equity. The lower the ratio, the better it is because it shows that the total equity owned by the company exceeds the long-term debts.
2.9.3 Equity Multiplier
Equity multiplier shows the asset ownership for each ringgit of equity. Debt ratio and equity multiplier provides the same information but in different approach. Debt ratio of 40% means that the company is being funded by 40% debts. Based on the balance sheet identity: | | | | | | Asset = Liability + Equity | | | | |
From this information, we know that the company is being funded by 60% equity. Equity multiplier is 100/60