THE WISDOM OF DEBT-EQUITY RATIO




There is a famous accounting ratio, called Debt-Equity Ratio. ‘Debt’ means ‘Borrowed Funds’ or ‘Loan Funds’ or ‘Owed Funds’. “Equity’ means ‘Owners’ Funds’ or ‘Own Funds’.


As a teacher of Accountancy, I have been teaching and discussing this ratio, among other accounting ratios, in my class, for decades. One of the hardest truths to digest about this ratio is the so-called standard Debt-Equity Ratio: It’s considered to be 2:1. It means, that your business is likely to thrive if your borrowed funds are at least double the size of your own funds.


Funny, isn’t it?


No, not for entrepreneurship. It’s argued, that if you want to grow faster, you need to take risks… Borrow money at interest… Mortgage, hypothecate and pledge every asset you own… And, be smart: Make so much profits, that you are able to pay off all your overheads, interest and taxes and still make profits for yourself and your fellow-partners or shareholders…


If all goes as per the plan, everybody will be happy… Your banker will die to lend you more and more… You will be able to raise loans without any securities… Suppliers will happily supply more and more goods to you on credit and never mind waiting for their money… And, the taxmen and your staff all will be happy… Importantly, your own friends and family.


The trouble will start, when your chips are down… When sales dip, losses mount… When you are unable to service your loans, leave alone repay… When your suppliers keep knocking on your door… When taxes mount, staff salaries remain unpaid…


Yes, now is the time you wonder if there was something wrong about the lesson learnt in your Management school… that, the standard Debt-Equity ratio should be 2:1… Else, you are not a smart businessman!


Even though I was hugely inspired by Napoleon Hill’s books – ‘Think and Grow Rich’ and ‘The Law of Success’… Even though I have read hundreds of ‘Success’ and ‘Motivational books’… and, even though, I myself have spent decades writing on ‘Success’ and ‘Motivational stuff’… I have remained only a teacher inside and a teacher outside. My own ‘Debt-Equity ratio has remained the ulta: 1:2 or 0.5:1. Perhaps, that’s what my ‘poor’ dad taught me!


The ‘smart’ business, has, somehow, not gone in my blood at all. I panic every time I borrow. But, borrow we all must, you see. The question is, whether I can withstand the winds when they blow hard against me… If my heart answers, ‘Yes’, it’s fine… Let me go all the way to the Banks. But, if my heart says ‘No’, then, I better listen to it.


Maybe, that’s why I still prefer a filter coffee of 20 bucks than 200-500-buck-cappuccino at the Starbucks, Barista or CCD. Yes, I don’t mind ‘killing my time’ in an Udupi joint or in the shade of a local garden than ‘there’…


Why am I saying all this today?


GERALD D’CUNHA

Pic.: Cafe Coffee Day


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