INTM579010 - Thin capitalisation: debt: equity ratio

Definition of debt:equity ratio

The simplest definition used for debt:equity ratio is the ratio of total debt to shareholders’ equity. There are a number of variations. For example, the liabilities may include only long- term debt, only interest-bearing long-term debt, or only subordinated debt. For the purposes of the discussion of debt:equity ratio in this module we shall use the following definition:

Debt:equity ratio = the ratio of the total interest-bearing debt to the shareholders’ funds (equity)

The idea of what constitutes debt is dealt with in INTM579020, and the idea of equity, or shareholders’ funds, is dealt with in INTM579030.

A high debt:equity ratio in relation to the norm for the type of business is usually regarded as an indication that a company has been aggressive in financing its growth with debt. The result can be volatile earnings from the effect of the additional interest expense.