Ratio of Liabilities to Stockholders' Equity Formula
Description: Analyzing the ability of a company to pay its creditors.
Total Liabilities/Total Stockholder’s Equity=Ratio of Liabilities to Equity.
Why is this formula important to analyze?
The Ratio of Liabilities to Stockholder’s Equity is important to analyze because is measures the degree which the assets of the business are financed by the debt and the shareholders equity of the business.
Both total liabilities and stockholders’ equity figures are obtained from the balance sheet of a business. Lower values of the ratio are favorable indicating less risk. Higher ratio is unfavorable because it means that the business relies more on external lenders; a higher risk.
For example, let say we were analyzing Company A, B, and C.
Company A shows favorable results since there ratio is lower than the other company on the list. It shows that there assets are financed more with investors or the owner cash. Company B show unfavorable results because they are using more of a credit line to support their business. They show more of risk because they need to pay off the lenders to keep them from defaulting on their payments. Company C is doing alright since there ratio is not extremely high and show that they can continue to operate without much credit.
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