Debt/Equity Ratio

Loading the player...

What is the 'Debt/Equity Ratio'

Debt/Equity Ratio is a debt ratio used to measure a company's financial leverage, calculated by dividing a company’s total liabilities by its stockholders' equity. The D/E ratio indicates how much debt a company is using to finance its assets relative to the amount of value represented in shareholders’ equity.

The formula for calculating D/E ratios can be represented in the following way:

Debt - Equity Ratio = Total Liabilities / Shareholders' Equity

The result may often be expressed as a number or as a percentage.

This form of D/E may often be referred to as risk or gearing.

2. This ratio can be applied to personal financial statements as well as corporate ones, in which case it is also known as the Personal Debt/Equity Ratio. Here, “equity” refers not to the value of stakeholders’ shares but rather to the difference between the total value of a corporation or individual’s assets and that corporation or individual’s liabilities. The formula for this form of the D/E ratio, then, can be represented as:

D/E = Total Liabilities / (Total Assets - Total Liabilities)

BREAKING DOWN 'Debt/Equity Ratio'

1. Given that the debt/equity ratio measures a company’s debt relative to the total value of its stock, it is most often used to gauge the extent to which a company is taking on debts as a means of leveraging (attempting to increase its value by using borrowed money to fund various projects). A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. Aggressive leveraging practices are often associated with high levels of risk. This may result in volatile earnings as a result of the additional interest expense.

For example, suppose a company has a total shareholder value of $180,000 and has $620,000 in liabilities. Its debt/equity ratio is then 3.4444 ($620,000 / $180,000), or 344.44%, indicating that the company has been heavily taking on debt and thus has high risk. Conversely, if it has a shareholder value of $620,000 and $180,000 in liabilities, the company’s D/E ratio is 0.2903 ($180,000 / $620,000), or 29.03%, indicating that the company has taken on relatively little debt and thus has low risk.

If a lot of debt is used to finance increased operations (high debt to equity), the company could potentially generate more earnings than it would have without this outside financing. If this were to increase earnings by a greater amount than the debt cost (interest), then the shareholders benefit as more earnings are being spread among the same amount of shareholders. However, if the cost of this debt financing ends up outweighing the returns that the company generates on the debt through investment and business activities, stakeholders’ share values may take a hit. If the cost of debt becomes too much for the company to handle, it can even lead to bankruptcy, which would leave shareholders with nothing.

2. The personal debt/equity ratio is often used in financing, as when an individual or corporation is applying for a loan. This form of D/E essentially measures the dollar amount of debt an individual or corporation has for each dollar of equity they have. D/E is very important to a lender when considering a candidate for a loan, as it can greatly contribute to the lender’s confidence (or lack thereof) in the candidate’s financial stability. A candidate with a high personal debt/equity ratio has a high amount of debt relative to their available equity, and will not likely instill much confidence in the lender in the candidate’s ability to repay the loan. On the other hand, a candidate with a low personal debt/equity ratio has relatively low debt, and thus poses much less risk to the lender should the lender agree to provide the loan, as the candidate would appear to have a reasonable ability to repay the loan.

Limitations of 'Debt/Equity Ratio'

1. Like with most ratios, when using the debt/equity ratio it is very important to consider the industry in which the company operates. Because different industries rely on different amounts of capital to operate and use that capital in different ways, a relatively high D/E ratio may be common in one industry while a relatively low D/E may be common in another. For example, capital-intensive industries such as auto manufacturing tend to have a debt/equity ratio above 2, while companies like personal computer manufacturers usually are not particularly capital intensive and may often have a debt/equity ratio of under 0.5. As such, D/E ratios should only be used to compare companies when those companies operate within the same industry.

Another important point to consider when assessing D/E ratios is that the “Total Liabilities” portion of the formula may often be determined in a variety of ways by different companies, some of which are not actually the sum of all of the company’s liabilities. In some cases, companies will only incorporate debts (like loans and debt securities) into the liabilities portion of the formula, while omitting other kinds of liabilities (unearned revenue, etc.). In other cases, companies may calculate D/E in an even more specific way, including only long-term debts and excluding short-term debts and other liabilities. Yet, “long-term debt” here is not necessarily a term with a consistent meaning. It may include all long-term debts, but it may also exclude long-term debts nearing maturity, which are then categorized as “short-term” debts. Because of these differentiations, when considering a company’s D/E ratio one should try to determine how the ratio was calculated and should be sure to consider other ratios and performance metrics as well.

  1. Capitalization Ratios

    Indicators that measure the proportion of debt in a company’s ...
  2. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  3. Leverage Ratio

    Any ratio used to calculate the financial leverage of a company ...
  4. Current Ratio

    The current ratio is a liquidity ratio measuring a company's ...
  5. Long Term Debt To Total Assets ...

    A measurement representing the percentage of a corporation's ...
  6. Debt/Equity Swap

    A transaction in which the obligations (debts) of a company or ...
Related Articles
  1. Investing

    Why do Debt to Equity Ratios Vary From Industry to Industry?

    Obtain a better understanding of the debt/equity ratio, and learn why this fundamental financial metric varies significantly between industries.
  2. Investing

    Understanding Leverage Ratios

    Large amounts of debt can cause businesses to become less competitive and, in some cases, lead to default. To lower their risk, investors use a variety of leverage ratios - including the debt, ...
  3. Investing

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  4. Investing

    Evaluating A Company's Capital Structure

    Learn to use the composition of debt and equity to evaluate balance sheet strength.
  5. Investing

    Analyzing Oracle's Debt Ratios in 2016 (ORCL, SAP)

    Learn how the debt ratio, debt-to-equity ratio and debt-to-capital ratio are used to evaluate Oracle Corp.'s liabilities, equity and assets.
  6. Investing

    Debt Ratio

    The debt ratio divides a company’s total debt by its total assets to tell us how highly leveraged a company is—in other words, how much of its assets are financed by debt. The debt component ...
  7. Markets

    Debt Reckoning

    Learn about debt ratios and how to use them to assess a company's financial health. You could save a lot of money!
  8. Markets

    4 Leverage Ratios Used In Evaluating Energy Firms

    These four leverage ratios can help investors understand how oil and gas firms are managing their debt.
  9. Investing

    Analyzing AT&T's Debt Ratios in 2016 (T)

    Learn about AT&T Inc. and its key debt ratios, such as the debt-to-equity ratio, interest coverage ratio and cash flow-to-debt ratio.
  10. Markets

    4 Leverage Ratios Used In Evaluating Energy Firms

    Analysts use specific leverage ratios to compare firms within an industry. A basic understanding of these ratios helps when evaluating oil and gas stocks.
  1. What debt to equity ratio is common for a bank?

    Take a look at the important debt-to-equity ratio, a key metric of financial leverage, and learn what the average debt/equity ... Read Answer >>
  2. What is a good debt ratio, and what is a bad debt ratio?

  3. What debt/equity ratio is typical for companies in the utilities sector?

    Discover how the debt/equity ratio is used to measure a company’s leverage, and learn the typical debt/equity ratios for ... Read Answer >>
  4. In what way is credit risk analysis beneficial when trading in the stock market?

    Learn how value investors use credit risk analysis in their determination of which investments to make, and understand how ... Read Answer >>
  5. What are the most common leverage ratios for evaluating a company?

    Learn more about some of the most common leverage ratios used by traders to determine whether a company is using debt in ... Read Answer >>
  6. What is the average debt/equity ratio of companies in the financial services sector?

    Learn the importance of calculating the debt to equity ratio when analyzing companies operating in the financial services ... Read Answer >>
Hot Definitions
  1. Glass-Steagall Act

    An act the U.S. Congress passed in 1933 as the Banking Act, which prohibited commercial banks from participating in the investment ...
  2. Quantitative Trading

    Trading strategies based on quantitative analysis which rely on mathematical computations and number crunching to identify ...
  3. Bond Ladder

    A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of ...
  4. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  5. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  6. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
Trading Center