Debt Ratios: Debt-Equity Ratio
AAA
  1. Debt Ratios: Introduction
  2. Debt Ratios: Overview Of Debt
  3. Debt Ratios: The Debt Ratio
  4. Debt Ratios: Debt-Equity Ratio
  5. Debt Ratios: Capitalization Ratio
  6. Debt Ratios: Interest Coverage Ratio
  7. Debt Ratios: Cash Flow To Debt Ratio

Debt Ratios: Debt-Equity Ratio

By Richard Loth (Contact | Biography)

The debt-equity ratio is another leverage ratio that compares a company's total liabilities to its total shareholders' equity. This is a measurement of how much suppliers, lenders, creditors and obligors have committed to the company versus what the shareholders have committed.

To a large degree, the debt-equity ratio provides another vantage point on a company's leverage position, in this case, comparing total liabilities to shareholders' equity, as opposed to total assets in the debt ratio. Similar to the debt ratio, a lower the percentage means that a company is using less leverage and has a stronger equity position.

Formula:


Components:



As of December 31, 2005, with amounts expressed in millions, Zimmer Holdings had total liabilities of $1,036.80 (balance sheet) and total shareholders' equity of $4,682.80 (balance sheet). By dividing, the equation provides the company with a relatively low percentage of leverage as measured by the debt-equity ratio.

Variations:
A conservative variation of this ratio, which is seldom seen, involves reducing a company's equity position by its intangible assets to arrive at a tangible equity, or tangible net worth, figure. Companies with a large amount of purchased goodwill form heavy acquisition activity can end up with a negative equity position.

Commentary:
The debt-equity ratio appears frequently in investment literature. However, like the debt ratio, this ratio is not a pure measurement of a company's debt because it includes operational liabilities in total liabilities.

Nevertheless, this easy-to-calculate ratio provides a general indication of a company's equity-liability relationship and is helpful to investors looking for a quick take on a company's leverage. Generally, large, well-established companies can push the liability component of their balance sheet structure to higher percentages without getting into trouble.

The debt-equity ratio percentage provides a much more dramatic perspective on a company's leverage position than the debt ratio percentage. For example, IBM's debt ratio of 69% seems less onerous than its debt-equity ratio of 220%, which means that creditors have more than twice as much money in the company than equity holders (both ratios are for FY 2005).

Merck comes off a little better at 150%. These indicators are not atypical for large companies with prime credit credentials. Relatively small companies, such as Eagle Materials and Lincoln Electric, cannot command these high leverage positions, which is reflected in their debt-equity ratio percentages (FY 2006 and FY 2005) of 91% and 78%, respectively.

Debt Ratios: Capitalization Ratio

  1. Debt Ratios: Introduction
  2. Debt Ratios: Overview Of Debt
  3. Debt Ratios: The Debt Ratio
  4. Debt Ratios: Debt-Equity Ratio
  5. Debt Ratios: Capitalization Ratio
  6. Debt Ratios: Interest Coverage Ratio
  7. Debt Ratios: Cash Flow To Debt Ratio
RELATED TERMS
  1. Net Premiums Written To Policyholder Surplus

    A ratio of an insurance company’s gross premiums written less ...
  2. Net Liabilities To Policyholders' Surplus

    The ratio of an insurer’s liabilities, including unpaid claims, ...
  3. Reserves To Policyholders' Surplus Ratio

    The ratio of an insurer’s reserves set aside for unpaid losses ...
  4. Insurance Regulatory Information System (IRIS)

    A collection of databases and tools used to analyze the financial ...
  5. Book Value Reduction

    Reducing the value at which an asset is carried on the books ...
  6. Deferred Tax Asset

    A deferred tax asset is an asset on a company's balance sheet ...
  1. Why are capital expenses (CAPEX) treated differently than current expenses?

    Learn the difference between capital expenditures, or CAPEX, and current expenses, and determine why they are treated differently ...
  2. Does a capital expenditure (CAPEX) immediately affect income statements?

    Learn the direct and indirect effects a capital expenditure, or CAPEX, may immediately have on a business' income statements ...
  3. What's the difference between capital expenditures (CAPEX) and operational expenditures ...

    Learn to distinguish between capital expenditures (CAPEX) and operational expenditures (OPEX) as listed on a company's income ...
  4. What's the difference between capital expenditures (CAPEX) and net working capital?

    Learn more about capital expenditures (CAPEX) and net working capital, two distinct but related measurements of a company's ...
Related Tutorials
  1. Investing Basics

    Industry Handbook

  2. Bonds & Fixed Income

    Investing For Safety and Income Tutorial

  3. Fundamental Analysis

    Discounted Cash Flow Analysis

  4. Economics

    American Depositary Receipt Basics

  5. Fundamental Analysis

    Ratio Analysis Tutorial

Trading Center