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Long Term Debt to Equity Ratio indicates the extent to which a company relies on external debt financing to meet its capital requirements. If a company can employ more debt and generate higher earnings than the amount needed to service the debt (i.e. interest charges), it improves the return to the shareholders as more earnings become available for distribution after payment of interest charges.
Since creditors have a first right of payment of their principal and interest, Long Term Debt Equity Ratio also highlights the risk for the shareholders of the company. This is especially true in times when the business is not generating enough to meet its debt obligations. Credit-rating agencies and analysts rely on this ratio to assess the creditworthiness of the company. In times of slowdown in economy, companies with high levels of debt find it increasingly difficult to service the interest charges on their borrowings as profit margins decline. Capital intensive industries like automobiles, steel, real estate, power etc generally have a higher Long Term Debt Equity Ratio since they need to purchase property, plants, and equipment to operate.
When calculating the Long Term Debt Equity Ratio on a consolidated basis the denominator will be the sum of, Net Worth and Minority Interest.
Also Read : – Ratio Analysis of Financial Statements
About the Author
Rajat Sharma is a well known stock market analyst and commentator. He has covered Indian markets for over a decade and is regarded for consistently identifying early stage investment opportunities. Attorney by qualification, Rajat has done extensive work for improving corporate governance and disclosure standards.Follow @SanaSecurities