What is the formula for calculating the debt-to-equity ratio?

By Jean Folger AAA
A:

Expressed as a percentage, the debt-to-equity ratio shows the proportion of equity and debt a firm is using to finance its assets, and the ability for shareholder equity to fulfill obligations to creditors in the event of a business decline. A low debt-to-equity ratio indicates lower risk, since debt holders have less claim on the company's assets. A higher debt-to-equity ratio, on the other hand, shows that a company has been aggressive in financing its growth with debt, and there may be a greater potential for financial distress if earnings do not exceed the cost of borrowed funds.

To calculate debt-to-equity, divide total liabilities by total shareholders' equity:

Debt-to-equity ratio = total liabilities / total shareholders' equity

For example, the balance sheet for Coca-Cola Co (KO) for the first quarter of 2014 shows (in millions) total liabilities of $58,635 and total shareholders' equity of $32,654. Using the above formula, the debt-to-equity ratio for KO can be calculated as:

Debt-to-equity = $58,635 / $32,654 = 1.8 (or 180%)

This means that KO has $1.80 of debt for every dollar of equity. During the same quarter, PepsiCo Inc (PEP) had a debt-to-equity ratio of 1.4, Dr Pepper Snapple Group Inc (DPS) had a ratio of 1.21, and the industry average for non-alcoholic beverages was 1.22, a new high for the industry, indicating that the industry (on average) is using more leverage to finance its assets. At 1.8, KO's debt-to-equity ratio is higher than both the industry average and at least two similar companies.

The debt-to-equity ratio can help investors identify companies that are highly leveraged and that may pose a higher risk. Investors can compare a company's debt-to-equity ratio against industry averages and/or other similar companies to gain a general indication of a company's equity-liability relationship. As with other financial ratios, it is more useful to compare various companies within the same industry than to look at only one company, or to attempt to compare companies from different industries. In addition, investors should consider more than one ratio (or number) when making investment decisions since one ratio cannot provide a comprehensive view of the company.

RELATED FAQS

  1. What are the main components of the Federal Reserve's balance sheet?

    Find out which items are listed as assets and liabilities on the balance sheet of the Federal Reserve, and how to read the ...
  2. What's more important, cash flow or profits?

    Learn about the different effects that cash flow and profit have on a business so you can decide which aspect to focus on.
  3. Which leverage ratios are most useful for analyzing manufacturing companies?

    See which leverage ratios investors and creditors are likely to use when analyzing the debt burdens for manufacturing companies.
  4. What are some examples of how cash flows can be manipulated or distorted?

    Read about some of the most common accounting techniques that can be used to manipulate the operating cash flow on a company's ...
RELATED TERMS
  1. Debt/Equity Swap

    A transaction in which the obligations (debts) of a company or ...
  2. Debt/Equity Ratio

    A measure of a company's financial leverage calculated by dividing ...
  3. Best's Capital Adequacy Relativity (BCAR)

    A rating of an insurance company’s balance sheet strength. Best’s ...
  4. Deferred Tax Asset

    A deferred tax asset is an asset on a company's balance sheet ...
  5. Working Capital

    This ratio indicates whether a company has enough short term ...
  6. Amortization

    1. The paying off of debt in regular installments over a period ...
Related Articles
  1. 5 Must-Have Metrics For Value Investors ...
    Active Trading

    5 Must-Have Metrics For Value Investors ...

  2. How Do Tech Companies Measure ROA And ...
    Fundamental Analysis

    How Do Tech Companies Measure ROA And ...

  3. How Sallie Mae Affects Student Loans
    Credit & Loans

    How Sallie Mae Affects Student Loans

  4. How to Use the Gearing Ratio
    Investing Basics

    How to Use the Gearing Ratio

  5. Saving Money Or Paying Off Debt?
    Credit & Loans

    Saving Money Or Paying Off Debt?

Trading Center