Debt Ratios: Debt-Equity 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

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.



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.

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.

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
  1. EBITA

    Earnings before interest, taxes and amortization. To calculate ...
  2. Qualitative Analysis

    Securities analysis that uses subjective judgment based on nonquantifiable ...
  3. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and ...
  4. Debt-Service Coverage Ratio (DSCR)

    In corporate finance, the Debt-Service Coverage Ratio (DSCR) ...
  5. Liquidity

    The degree to which an asset or security can be quickly bought ...
  6. Gross Profit

    A company's total revenue (equivalent to total sales) minus the ...
  1. What is a good debt ratio, and what is a bad debt ratio?

    Debt ratios can be used to describe the financial health of individuals, businesses or governments. Like other accounting ... Read Full Answer >>
  2. Does working capital measure liquidity?

    Working capital is a commonly used metric, not only for a company’s liquidity but also for its operational efficiency and ... Read Full Answer >>
  3. How do I read and analyze an income statement?

    The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>
  4. How can companies use the cash flow statement to mislead investors?

    Cash flow is a means for most investors to examine the actual economics of a business they might invest in, especially from ... Read Full Answer >>
  5. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>
  6. What is a profit and loss (P&L) statement and why do companies publish them?

    A profit and loss (P&L) statement, or balance sheet, is essentially a snapshot of a company's financial activity for ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!