Debt-to-Equity Ratio: How to Calculate Debt-to-Equity Ratio

A company's debt-to-equity ratio is a financial ratio that compares its total liabilities with its shareholders' equity. Also abbreviated as a D/E ratio, it is calculated using the formula:

Debt-to-Equity Ratio = Total Liabilities / Total Shareholders' Equity

Understanding the difference between liabilities and equity is essential to calculating a company’s debt-to-equity ratio.

• Total liabilities: Liabilities can be thought of as the company's total debt obligations. Liabilities like short-term debt, accounts payable, and annual taxes are regarded as less risky than long-term debt (such as multi-year loans).
• Total shareholders' equity: A shareholder's equity (also called a stockholder's equity) is the amount of money an investor has put into a company. This is not based on the initial amount of money they invested in the company, but rather on the current value of their shares. When you pool the equity of each individual stockholder, you arrive at the company's total equity.

A debt-to-equity ratio is a type of leverage ratio that paints a picture of a company's solvency. It is almost always listed on a company's balance sheet along with other financial statements.

Low debt-to-equity ratios often foretell a better return on investment. If a company has lower debt levels than its industry average, it can improve its market capitalization. Companies with lower ratios indicate that fewer of the company's total assets will have to go toward servicing debt. It suggests (but does not guarantee) that a company's capital structure can endure an economic downturn and that investors' money will be protected.

High debt-to-equity ratios can harm future profitability. As a company takes out business loans, it assumes a higher debt-to-equity ratio. A small business saddled with high debt financing may have to allocate more of its cash flow toward paying down that debt, particularly if its lenders raise interest rates.

Business owners and managers can calculate their company's debt-to-equity ratio using a simple division equation:

Debt-to-Equity Ratio = Total Liabilities / Total Shareholders' Equity.

The numerator is the company's total debt. This typically includes both short-term debt and long-term debt. Some financial analyses pay special attention to long-term debt, which can be more capital-intensive if interest rates rise.

The denominator is the company's total equity. This metric represents the value of shareholder investment in the company, such as the value of common stock and preferred stock.

A debt-to-equity ratio measures the financial leverage of a company. It is one of many financial ratios (or gearing ratios) that help illustrate a company's overall fiscal health. A D/E ratio can reveal:

• The total value of a company's assets: In business accounting, assets equal the sum of a business's liabilities plus equity—which are the same two components that go into a D/E ratio. Note that the book value of a company's assets can be manipulated by accountants, so investors and lenders usually require many financial statements that go beyond a simple debt-to-equity ratio.
• Future financial expenditures: As a general rule, companies with higher debt will have to dedicate more money to pay off that debt over time. For example, startups often take on large amounts of debt to get their operations running. If the business continues to have a high D/E ratio after operating for several years, however, it may have trouble balancing its books when the loans come due.
• Industry-specific information: The industry average for debt-to-equity ratios can vary considerably. Utilities (electric companies, gas companies, telecom companies) are known for carrying high levels of debt, but they have a reliable marketplace that will increase as populations expand. On the other hand, if a small business like a bakery or a record label has tremendous amounts of debt, its future revenue may not be enough to pay down that debt while also protecting its investors' equity.

All investments and investment strategies entail inherent risks and introduce the potential for financial loss or the depreciation of assets. The information presented in this article is for educational, informational, and referential purposes only. Consult a professional investment advisor before making any financial commitments.

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