Financial Ratios Part 6 of 21: Debt-To-Equity Ratio
How much of my farm or business is owned by me vs. the bank?
Financial Ratios can assist in determining the health of a business. There is a minimum of 21 different ratios that can be looked at by many financial institutions. You cannot look at a single ratio and determine the overall health of a business or farming operation. Multiple ratios must be used along with other information to determine the total and overall health of a farming operation and business. This series of articles will look at 21 commonly used ratios.
The Debt-To-Equity ratio is a measure of Solvency and is determined based on information derived from a business’ or farm operations balance sheet. The term Solvency refers to the ability of a farm or business to pay all of its debt if it were to have to immediately sell the business or farming operation. The Debt-To-Equity ratio specifically measures the amount of the business or farm that is owned by the bank vs. the owner/operator. It is an indicator to how much of the farm or business has been leveraged in debt.
To determine the Debt-To-Equity ratio you divide the Net Worth by the Total Assets.
Debt-To-Equity ratio =
The higher the percentage the less of a business or farm is leveraged or owned by the bank through debt. This ratio is typically used by creditors to quickly determine the amount of risk they will be taking on by providing financing to the business or farm. The higher the number the more of the farm or business is leveraged (the higher the debt load). A number of 1.5 would mean that the business or farm has a heavy debt load and its borrowing capacity may be severely limited.
If you have any further question please feel free to contact your local Farm Management Educator or the author. '
Information for this article has been modified and gathered using material created by the University of Minnesota Center for Farm Financial Management (CFFM)
You can read the other articles in this series:
Part 1: The current ratio
Part 2: Working capital.
Part 3: Working capital to gross revenues
Part 4: Debt-to-asset ratio
Part 5: Equity-to-asset ratio
Part 7: Net farm income
Part 8: Rate of return on assets
Part 9: Rate of return
Part 10: Operating profit margin
Part 11: The EBITDA measurement of profitability
Part 12: Operating profit margin
Part 13: Capital debt repayment margin
Part 14: Replacement margin
Part 15: Term debt coverage
Part 16: Replacement margin coverage ratio
Part 17: Asset turnover rate
Part 18: Operating-expense ratio
Part 19: Depreciation-expense ratio
Part 20: Interest-expense ratio
Part 21: Net income ratio