The ratio should take values above 1 (it means that own financing prevails over foreign financing, i.e. debt). Low ratio levels (below 1) are interpreted as substantial debt of the company and low creditworthiness (high ratio levels in turn are interpreted as low debt and high creditworthiness and debt capacity).
An optimal capital structure is the best mix of debt and equity financing that maximizes a company's market value while minimizing its cost of capital. Minimizing the weighted average cost of capital (WACC) is one way to optimize for the lowest cost mix of financing.
Optimal capital structure is determined by a debt-to-equity ratio, which should equal around 1 for most companies. The ratio equation is liabilities/equity, which means a company needs to know its liabilities, which are things like loans and other expenses, like wages and warranties, and equity.
However, there are some basic guidelines that can be used to identify desirable and undesirable ratios: A high gearing ratio is anything above 50% A low gearing ratio is anything below 25% An optimal gearing ratio is anything between 25% and 50%
A working capital ratio of between 1.5:2 is considered good for companies. This indicates that a company has enough money to pay for short-term funding needs.
To determine the company's optimal capital structure, the company needs to take into account factors such as weighted average cost of capital, risk and expected return, business risk, industry averages, the potential cost of financial distress, company's tax status, and application of financial models for this purpose.
A good debt-to-equity ratio is typically a low D/E ratio of less than 1. However, what is actually a "good" debt-to-equity ratio varies by industry, as some industries (like the finance industry) borrow large amounts of money as standard practice.
The line E(Rc) = Rf + Spσ(Rc) is the capital allocation line (CAL). The slope of the line, Sp, is called the Sharpe ratio, or reward-to-risk ratio. The Sharpe ratio measures the increase in expected return per unit of additional standard deviation.
As a rule of thumb, a good range of WACC values for mature companies spans about 2-3% from the minimum to the maximum. So, 10-12% or 6-9% would be fine. But 5-10% might be a bit too wide, and 5-15% would be too wide to be useful. (Exceptions apply in emerging markets and for more speculative companies.)
A gearing ratio is a measure used by investors to establish a company's financial leverage. In this context, leverage is the amount of funds acquired through creditor loans – or debt – compared to the funds acquired through equity capital.
The optimal capital structure is achieved when a firm's cost of capital (WACC) is minimized and its firm value is maximized. The trade-off theory states that firms must analyze the benefits from the tax-deductibility of debt to the potential risk of bankruptcy and financial distress.
For example, if a company has determined that its optimal capital structure is 22.5% debt and 77.5% equity but finds that its current capital structure is 23.1% debt and 76.9% equity, it is close to its target. Reducing debt and increasing equity would require transaction costs that might be quite significant.
Using the above findings, we define the 'golden ratio-based' capital structure as one consisting of 38.2% equity and 61.8% debt.
The minimum tier 1 capital ratio required by financial regulators is 6%. Anything under this threshold means that a bank isn't adequately capitalized. This means that a ratio over 6% is desired so a higher tier 1 capital ratio means it is better able to withstand any financial troubles.
Acceptable Range. For most companies, an acceptable debt-to-equity ratio falls between 1.5 and 2. Larger companies can sometimes sustain a higher ratio. However, a ratio much above 2 can indicate that the company is taking on too much debt, which could be risky.
A debt ratio between 30% and 36% is also considered good. It's when you're approaching 40% that you have to be very, very vigilant. With a threshold like that, you're a greater risk to lenders.
Amazon debt/equity ratio for the quarter ending September 30, 2024 was 0.21. Amazon average debt/equity ratio for 2023 was 0.36, a 14.29% decline from 2022. Amazon average debt/equity ratio for 2022 was 0.42, a 10.53% decline from 2021. Amazon average debt/equity ratio for 2021 was 0.38, a 2.56% increase from 2020.
Generally, a good debt ratio for a business is around 1 to 1.5. However, the debt-to-equity ratio can vary significantly based on the business's growth stage and industry sector. For example, newer and expanding companies often utilise debt to drive growth.
The calculation for this ratio is total debt divided by total equity. The long-term debt to capitalization ratio (one of several capitalization ratios) compares long-term debt to the capital structure of a company. (The capital structure of a company refers to its long-term debt and total shareholder equity.)
Since Debt is almost always cheaper than Equity, Debt is almost always the answer. Debt is cheaper than Equity because interest paid on Debt is tax-deductible, and lenders' expected returns are lower than those of equity investors (shareholders). The risk and potential returns of Debt are both lower.
Investors usually look for a company to have a debt ratio between 0.3 (30%) and 0.6 (60%).
A good working capital ratio (remember, there is no difference between current ratio and working capital ratio) is considered to be between 1.5 and 2, and suggests a company is on solid ground.