What is Debt to Equity Ratio & What Does It Mean? (with Formula)

 

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Debt/Equity Ratio or Debt to Equity Ratio or D/E Ratio is a popular financial ratio used by many businesses around the world. Both business and investors benefit from this formula for quick and easy decision making.

What is Debt to Equity Ratio?

Debt to Equity ratio measures the total debt or the liabilities of the company as a portion of the company's equity. This gives an indication of the capital structure of the company; owner's funds vs debt funds.

Equity is the owner's or shareholder's interest in the company, and debts are what is owed by the company to outsiders.

Debt to Equity Ratio = Total Debt / Total Equity

Debt to Equity Ratio = (Total Short Term Debt + Total Long Term Debt) / Shareholder Equity

What Does Debt to Equity Ratio Mean?

The result of the Debt to Equity ratio gives an indication of the risk undertaken by the company in financing its assets. 

A higher D/E ratio signals that the outsiders (lenders, creditors etc) have a higher claim on the company's assets. On the flip side, it also suggests that the owners of the business (entrepreneur, shareholders etc) have less claim on the company's assets thus less control even.

A higher D/E ratio also means that any further potential borrowing money for the company will be very difficult. Even if they do secure loans, it will be at a higher cost than usual. Nobody wants to restrict their cash in a company where owners have less control/interest/ownership of the company.

One possibly plus point for a high Debt to Equity ratio is that it shows that the owners were able to retain the control of the company with a limited investment. However, this does not look so good for outsiders.

Hence, naturally a lower D/E ratio is preferred for a company with regards to the risk it undertakes.

What is Debt to Asset Ratio & What Does It Mean? (Formula)

 

Debt to Asset ratio or Debt/Asset ratio is one of the basic financial analysis ratios used by businesses around the world. This simple ratio gives, both the business as well as potential investors, valuable and quick information on the solvency of the company.

How to Measure Debt to Asset Ratio? (Formula)

The formula is in the name of the ratio itself. So, remembering the formula for students is quite easy. Debt to Asset ratio is measured by dividing the total of debt obligations of the company by its asset base.

Debt to Asset Ratio = Total Debt / Total Assets

Debt to Asset Ratio = (Short Term Debt + Long Term Debt) / (Current Assets + Fixed Assets)

What Does Debt to Asset Ratio Mean?

The resulting value of this ratio gives an indication of how much of total debt obligations or liabilities are covered by its assets. 

The value can range from 0 to 1, and usually the higher the number is considered to be worse.

For an example; if a company has a Debt to Asset ratio of 0.7, it means that 70% of the company's assets will have to be sold to cover up the debt obligations in case of company closure. This naturally is a much worse situation as there will be less asset value for the owners of the company.

A high Debt to Asset ratio signifies a high leverage of the company's assets. Higher leverage usually hints a higher risk for the company as more assets are under risk of being restricted to resolve company debts.

Hence, a lower Debt to Asset ratio (usually less than 0.5) is considered to be favorable for a company.

Categorization of Large Scale Enterprises (LSE) and Small and Medium Scale Enterprises (SME)?

There are several ways of categorizing a business to serve different purposes. A business may be classified as small scale for tax purposes and classified as medium scale for its number of employees. Also, a business could be categorized based on its ownership, nature of business, market and many more criteria.

In this article, we aim to talk about one such categorization of enterprises-based on scale.

How to Measure the Scale of an Enterprise?

Categorization of scale of an enterprise is not a standard measure. There could be factors that comes into consideration, such as; number of employees, turnover, profits, market share, number of customers/suppliers, production capacity, technology utilization and many more.

As a standard norm, based on the number of employees (which is an accepted measure of scale of an organization around the globe), below are the benchmarks to decide scale;

• Large Scale Enterprises: People more than 250. (Consists 1% of all enterprises in the world)
• Medium Scale Enterprises: People between 50 to 250
• Small Scale Enterprises: People less than 50

As a basis of revenue, a standard measure of scale is as follows;

• Large Scale Enterprises: annual revenue over $1 billion
• Medium Scale Enterprises: annual revenue $10 million - $1 billion
• Small Scale Enterprises: annual revenue $5-$10 million

Geographical spread;

• Large Scale Enterprises: could be spread internationally
• Medium Scale Enterprises: spread across several cities of one country
• Small Scale Enterprises: mainly one location within one country or city

Technology adoption;

• Large Scale Enterprises: heavy reliance on advanced technology
• Medium Scale Enterprises: moderate level of technology integration to day-to-day processes
• Small Scale Enterprises: little to no technology utilization. Most work is done manually.

However, these categorizations and definitions could vary largely from country to country. For the closest benchmark, a country's national statistics should be used as a tool of measure. For an example, a large scale enterprise in Thailand could be a small scale venture in the United States.

What is Zero Based Budgeting? How to Do Zero Based Budgeting (ZBB)?

Zero-Based Budgeting is a concept in management accountant where the company budgets are drawn up from scratch. The company might or might not be having a budget from the previous year, however, the company can still engage in Zero-Based Budgeting.

Usually, an annual budget is based on either the previous year budget or the previous year actual financials. However, in this concept, the budget is based on '0' value, hence all revenues and costs have to be justified from the start.

Why Zero-Based Budgeting?

A Zero-Based Budget could be adopted by a company for various reasons. If a company is just starting their budgets for the first time, they have to adopt a Zero-Based Budget. However, if a company has been practicing budgeting for a while and still decides on ZBB, it could be attempting to fix a mistake in budgeting, due to drastic changes in the organization or to re-validate their revenue/cost structure.

How to Perform Zero Based Budgeting?

There are several steps involved in ZBB which must be followed to derive optimum results.

1. Identify revenue components and cost components
2. Looking at ways of achieving these revenue and cost components
3. Evaluating options--this is where the numbers are considered for the budget. Hence, each and every revenue and expense has to be justified, in comparison with alternative options.
4. Putting the numbers to the budget

Example of Performing Zero-Based Budget

Company 'A' had a budget for financial year (FY) 2017. However, if the company wishes to develop a Zero-Based Budget for FY 2018, they will have to scratch off the last year's budget completely and start from zero. First of all, the company has to look at their revenue avenues and assign numbers by justifying them. The justification should be supported by contracts and communications with marketing staff. 

Next, they have to look at the costs associated with the revenues and evaluate different options of spending. The company has to evaluate these options and decide on the best choice. The company may have to call up proposals from different vendors/stores to compare prices/quality/specifications and decide on the best options for the company. This means that the company will not rely on last year's quotations or prices or costs for the next year's budget.

Advantages of Zero-Based Budgets

1. Figures would be more accurate and timely
2. Redundant costs will be removed from budgets or heavily slacked
3. Budget will reflect the true situation of the company in the year to come
4. Any structural changes can be easily included into the budget
5. Goal/objective driven
6. Likely to cause an improvement in profitability over last year's budgets
7. Ability to discover hidden costs/wastage/improvement opportunities in the business

Disadvantages of Zero-Based Budgets

1. Quite time consuming since all costs and revenues have to be evaluated and justified
2. Might be expensive to formulate the budget
3. The budget will lack prior budget's expertise
4. Might be difficult to achieve the budget since ad-hoc costs could occur

It is also noteworthy that Zero-Based Budgeting is most applicable in deriving the figures for costs, which is the area of the company that needs the most attention.

If you have any comments or questions about this article, do reach out to us. We will always try to help you further.

What is Reverse Logistics?

We have all heard of logistics or forward logistics. It is a crucial part of any business or organization as it can be seen as the function that pumps in resources (inbound logistics) to the organization and pumps out products (outbound logistics) to its customers. Hence, without logistics a business would come to a standstill.

What is Reverse Logistics?

The typical definition for reverse logistics states that stands for all operations related to reuse of products and materials.

In normal terms we can define reverse logistics as the act of returning products and materials at least one step backwards in the supply chain.

Reverse Logistics has to do with recovering products or materials from their final destination. Usually, this is done in order to recall products or materials for reuse or destruction. Reverse logistics is as popular as logistics in this day of transportation.

Why Reverse Logistics?

Reverse Logistics or Backward logistics have sprung up as a result of the need to reuse products or materials and recapture the value. It has come to a point in the economic world that destruction of a product or material is not a simple task. Especially when it comes to toxic products or materials and even medicines, very special precautions need to be taken to destroy them. The manufacturer cannot simply rely on the retailer to perform that duty. Hence, a product recall is needed.

There could be products with incorrect labeling, outdated pricing, incorrect packaging and so on. These products need to be recalled immediately as well. 

How Do Reverse Logistics Happen?

Reverse logistics could be as simple as transporting some goods from the retailer back to a warehouse, to reversing the products back to the manufacturer to recycle or even destroy. There could be instances where there are a few final destinations and even worst case scenarios where the products are with the end consumer. 

Other instances are when reverse logistics is coupled with logistics, i.e. when recalled products are transported in the same delivery vehicles used for logistics as a result of route optimization. 

 Most times recalled products need to be stored separately when delivering and back in the warehouses. Hence, special tracking mechanisms should be incorporated to avoid a very costly mistake.

What is Market Segmentation?

Marketers use a wide variety of tools to come up with a marketing stratgey for the organization. The types of products available and introduced, the advertisements, distribution channels and customer touch points are all part of the game. However, a major area where companies fail to recognize is the different needs of the customers.

Categorizing similar needs of customers into clusters is called segmenting the market. The segments can be broken down in terms of customer income, unique needs, geographical conditions, social statuses, education, religion, ethnicity and the list goes on.

There are no rules set in stone to segment a market. As long as you are able to cluster a group of people with similar needs and wants, it can be called a market segment. Once you have segmented the market, the business can cater to each segement based on their unique needs.

Some popular market segments are as follows:

1) Geographic Segmentation

This is a scenario where the market is divided based on the geographical location of the customers. Global marketing heavily relies on this segmentation as they consider one nation to be a unique market. However, it is not mandatory to assume that one nation is one unique market. For an example; although India and Sri Lanka can be considered as very unique markets even though they are situated in close proximity, Denmark and Norway could be clustered together. But depending on the sensitivity of the product to cultural factors these segmentations could change.

2) Demographic Segmentation

This segmentation focuses on factors such as age, gender, education level, income level, religion, ethnicity etc. Age group is a popular segmentation method, for an example, in the confectionary, toys and education businesses. Gender plays a major role in the fashion industry. For an example if a business is looking at opening a clothing store in a city, it should conducted a census and find out the percentage of men and women in the area so it can better cater to the target market.

Likewise, a market can be segmented to any number of manageable sectors and then a business can better focus on one segment.

Depending on the needs of the segments a business can;
- provide one product to the entire market,
- provide one product to several like-minded segments, or
- provide a unique product to all segements of the market.

Importance of Market Segmentation

- better identify the unique and varying needs of a market
- can better cater to the unique needs of the market
- personalized products give more value to customers, hence more customer satisfaction
- easier to handle a smaller segment than handling the entire market
- chances of a product failing in a segment is less
- can focus the business's marketing more effectively to a segment

If you have further questions regarding market segmentation please comment them below.

What is DMAIC and It's Uses

DMAIC is a popular model used for problem solving in organizations. This tool has been adopted by many Kaizen gurus due to the methodical approach used in DMAIC tool. This is also a prominent tool used in Six Sigma processes.

This tool can be used to identify problems within the organization and resolve them in a systematic manner.

In Kaizen, DMAIC tool is used a lot since it can deliver change in a standardized manner. And DMAIC can be used in a cyclical manner for problem solving and improvement, which is a core concept of Kaizen.

What does DMAIC stand for?

1. Define
2. Measure
3. Analyse
4. Improve
5. Control

Define

First step of this process is to identify the problem that you need to tackle. This is called 'defining' your problem. There is no strict guidelines as to how this can be done. You can write a few sentences about the problem at hand and the current situation of it.

Measure

The second step of the DMAIC process is to quantify your problem. By this way, you always have supporting evidence to backup your problem statement as well as objectives of your DMAIC project.

Also measuring helps you evaluate the before and after results so you can identify if your DMAIC project was fruitful.

Measuring criteria largely depends on the issue you are tackling. For an example: if you are trying to identify the reasons for loss of productivity in a production line, you could probably start by measuring the times taken by each activity and determine the lagging indicators.

It is important to know that measuring doesn't necessarily mean collecting numbers. It could be any type of qualitative data too.

Analyse

Analyse essentially has to do with crunching the numbers you gathered before. Do not mistake that it is just numbers that you can analyse. You can analyse qualitative data too.

Analyse step should be used to derrive at a plausible solution to your problem. Since your problem and solution is backed by extensive data and numbers, there is little chance that your solution will fail.

Improve

The fourth step of the DMAIC model is to implement your solution that is going to improve the current context of the problem. Notice the word "improve" being used as opposed to "solving." This is to mean that DMAIC model should be used to provide an improvement over the current problem. The solution that you derive might not eliminate the problem. Instead DMAIC focuses on continuously improving from the current status to a better status. This is why DMAIC is also identified as a cyclical process.

Control

The final step of DMAIC model is to ensure that the achieved improvement is sustained. For this you can implement one or more control mechanisms or points. These control points will ensure that the process does not slide back to its original status.

After one cycle of DMAIC is completed you can start working on your next project starting from the achieved and sustained improvement. So any shortcomings that were overlooked in the first cycle can be improved in the second cycle. Likewise, DMAIC can be used in turns to achieve the optimum result for any problem at work place.