Debt to Equity Ratio is: Definition and Formula

The health of a company is not only judged by sales or the quality of its human resources, but also based on its internal financial perspective. One of them is by measuring the debt to equity ratio or measuring the debt to equity ratio.

Debt to equity ratio or DER is the ratio of debt to equity. This is also known as the debt-to-equity ratio. The definition of debt to equity ratio is a financial ratio that compares the amount of debt with the value of equity. 

The value of equity and the amount of debt used for the company's operational activities must be in a fairly proportional amount.

The debt to equity ratio is also often referred to as the leverage ratio or leverage ratio, which means the ratio used to measure the value of an existing investment in a company.

Therefore, the debt to equity ratio is the main financial ratio that must be carried out in a company. Why? Because the debt to equity ratio is used to measure the value of the company's financial position.

How to Calculate Debt to Equity Ratio 

A certain formula is needed to calculate the Debt to equity ratio, the formula is “Debt to equity ratio (DER) = Total debt: Equity.

With a note:

Debt or liability is an obligation that must be paid by the company in cash to the creditor within a certain period of time. Debt is further divided into three categories based on the repayment period, namely current liabilities, long-term liabilities, and other liabilities.

Equity is a company's property rights over an asset or company assets in which there is a net worth. Equity will consist of the company owner's deposit and the remaining retained earnings.

Current liabilities or current liabilities are a form of obligation that is more short-term in nature, and tends to be considered a matter of course. 

Generally, current liabilities are company debts that are more related to the company's operational activities and are short-term, such as debts to suppliers, paying salaries, or debts for purchasing a tool to fulfill production activities.

Long-term liabilities are types of debt that are dangerous and should be avoided by the company. Generally, long-term debt has a large nominal and interest, such as loans from banks or other parties.

When current liabilities are greater than long-term liabilities, it can still be considered reasonable. But if the opposite is true, then it could be a sign of an unhealthy company. If long-term liabilities are greater than current liabilities, then the threat that will occur to the company is a liquidity disturbance.

As an Evaluator

Debt to Equity RatioThe calculation of the Debt to Equity Ratio must be done carefully and thoroughly because the Debt to Equity Ratio is a very important number and is needed in calculating the financial statements of a company. The health of the company's financial condition will depend on the Debt to Equity Ratio report.

If it turns out that the value of the debt to equity ratio increases, then the company means getting funding from debt lenders or investors. 

So, they do not get income from their own company. This is very dangerous and must be monitored closely, because the company must of course pay the debt that has been borrowed within a certain period of time.

The creditors or investors tend to prefer companies with low debt to equity ratios, because investors' assets will remain safe if a loss occurs. The higher the value of the Debt to Equity Ratio, the higher the amount of debt that must be paid off by the company within a certain period of time.

For this reason, companies that have a small debt to equity ratio will find it easier to get funding from various investors. A small Debt to Equity Ratio value also indicates that the company has small debt obligations. So, it will be more profitable for investors who want to do funding.

A careful and accurate calculation of the debt to equity ratio is required in order to avoid various mistakes. For company leaders, of course, they must be more careful and smart in taking capital, in the production and marketing processes, so that the debt ratio is not too high.

Debt to Equity Ratio and Income Tax

The Indonesian government apparently issued regulations regarding the Debt to Equity Ratio. The Minister of Finance then issued a provision regarding the size of the debt to equity ratio in the Minister of Finance Regulation No. 169/PMK.010/2015 which contains the determination of the ratio between debt and company capital for the purposes of calculating income tax.

Some of these regulations contain very important matters, namely: The provisions on the value of the Debt to Equity Ratio (DER) apply to all taxpayer entities established and located in Indonesia whose entire capital is divided into several shares The value of debt and capital is calculated from the average balance an average of one tax year or part of a tax year.

The maximum value of the ratio of debt and equity is 4:1.

There are some exceptions for several groups of taxpayers, namely banks, insurance, mining, financing institutions, and all institutions whose income is subject to income tax and these taxpayers run their business in the infrastructure sector.

If the DER value exceeds 4:1, then the borrowing cost that can be calculated is the amount of borrowing costs in accordance with a 4:1 ratio.

Borrowing costs contain loan interest, discounts and premiums, as well as other costs related to loans, finance lease expenses, fees for guaranteeing debt repayments and foreign currency loan differences.

If the taxpayer has an equity balance of zero or less than zero, then all borrowing costs cannot be taken into account in calculating taxable income.

This new provision has been in effect since the 2016 fiscal year.

Further implementation provisions will be regulated by the Regulation of the Director General of Taxes on

Debt to Equity Ratio Assessment

Usually, the optimal value of debt to equity ratio in a company is around one time, where the total debt equal total equity. However, this ratio cannot be equated from one type of industry to another. Why? Because this depends on the proportion of current assets and non-current assets in the industry.

The more assets or non-current assets, the more equity value is needed to finance long-term investments.

For most companies today, the acceptable debt to equity ratio is around 1.5 to two times. For companies that have gone public, the acceptable debt to equity ratio is 2 times or more. However, for small and medium-sized companies, this figure is not well received.

Generally, a high debt-to-equity ratio will indicate that the company is unable to generate sufficient funds to meet its debt obligations. However, a low debt-to-equity ratio can also indicate that the company is not able to maximize its profits.

Conclusion

Overall, the debt to equity ratio is one of the important indicators to assess the financial health of a company. Debt to equity ratio will describe the level of independence in a company regarding debt. 

The lower the debt to equity ratio, the better. However, the debt to equity ratio is not the only good indicator to assess a company's finances.

Just as we discussed earlier, that the debt to equity ratio is closely related to the company's expenses and equity, so the calculation of the debt to equity ratio is very dependent on the financial statements.

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