Debt Equity Ratio and Capital Gearing Ratio
Chapter Thirty-One
Syllabus topic 2, "Balance Sheet Ratios : i) Current Ratio ii) Liquid Ratio iii) Stock Working Capital Ratio iv) Proprietary Ratio v) Debt Equity Ratio vi) Capital Gearing Ratio"
Pages 82 to 84 of 162
The debt equity ratio
Debt equity ratio = Long-term debt / Proprietors' funds
Expressed as "x to 1". The conventional standard is 2 to 1, and for many Indian companies a lender looks for 1 to 1 or better.
| Element | What is in it |
|---|---|
| Long-term debt | Debentures, term loans, public deposits repayable after a year, and the long-term part of any borrowing. Not creditors, not a bank overdraft repayable on demand |
| Proprietors' funds | Equity share capital + preference share capital + reserves and surplus, less fictitious assets |
What it measures: how many rupees the outsiders have lent for every rupee the owners have put in.
Worked on Sunrise
| 2026, Rs | 2027, Rs | |
|---|---|---|
| 10 per cent debentures | 4,00,000 | 4,00,000 |
| Long-term debt | 4,00,000 | 4,00,000 |
| Proprietors' funds | 13,40,000 | 15,00,000 |
| 2026 | 2027 | |
|---|---|---|
| Debt equity ratio | 0.30 to 1 | 0.27 to 1 |
Sunrise has borrowed 27 paise for every rupee its owners have put in. That is very conservative, far below the 2 to 1 standard, and the ratio improved because the debentures stayed still while the reserves grew.
Some questions define it the other way
A minority of books put proprietors' funds on top and debt below, or use total debt including current liabilities. All are defensible; state your formula. MU's own questions use long-term debt over proprietors' funds, which is what is given here.
The capital gearing ratio
Capital gearing ratio = Fixed-return capital / Equity shareholders' funds
Expressed as "x to 1". There is no standard; the answer is a description, not a score.
| Element | What is in it |
|---|---|
| Fixed-return capital | Preference share capital + debentures + long-term loans. Anything whose return is fixed by contract |
| Equity shareholders' funds | Equity share capital + reserves and surplus, less fictitious assets. Preference capital is NOT here |
What it measures: how much of the long-term capital carries a return that must be paid whatever the year brings.
Worked on Sunrise
| 2026, Rs | 2027, Rs | |
|---|---|---|
| 9 per cent preference share capital | 2,00,000 | 2,00,000 |
| 10 per cent debentures | 4,00,000 | 4,00,000 |
| Fixed-return capital | 6,00,000 | 6,00,000 |
| 2026, Rs | 2027, Rs | |
|---|---|---|
| Equity share capital | 10,00,000 | 10,00,000 |
| Reserves and surplus | 1,40,000 | 3,00,000 |
| Equity shareholders' funds | 11,40,000 | 13,00,000 |
| 2026 | 2027 | |
|---|---|---|
| Capital gearing ratio | 0.53 to 1 | 0.46 to 1 |
Where preference capital sits, side by side
This table is the answer to the question that asks you to distinguish them.
| Debt equity ratio | Capital gearing ratio | |
|---|---|---|
| Numerator | Long-term debt | Fixed-return capital: preference + debt |
| Denominator | Proprietors' funds, including preference | Equity funds, excluding preference |
| Preference capital is | In the denominator, as owners' money | In the numerator, as fixed-return money |
| Question asked | How much have we borrowed against what we own | How much of the capital carries a fixed charge |
| Standard | 2 to 1, often 1 to 1 in practice | None |
| For Sunrise, 2027 | 0.27 to 1 | 0.46 to 1 |
The rest of this chapter
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The rest of this subject
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