What Is The Debt-To-Equity (D/E) Ratio?
Debt-to-equity (D/E) ratio measures how much a corporation relies on debt to support its operations rather than wholly-owned cash.
The debt-to-equity (D/E) ratio is computed by dividing a company’s total liabilities by its shareholder equity to determine the use of borrowed money (debt) to finance the purchase of assets.
Higher leverage ratios usually mean that a firm or stock may pose a greater risk to investors.
Debt/Equity = Total Liabilities / Total Shareholder’s Equity
The information needed for the D/E ratio is on a company’s balance sheet. Business owners use a variety of software to track D/E ratios and other financial metrics. Microsoft Excel provides a balance sheet template that automatically calculates financial ratios such as the D/E ratio and debt ratio.
What counts as a “good” debt-to-equity (D/E) ratio will depend on the nature of the business and its industry. Generally speaking, a D/E ratio below 1.0 would be seen as relatively safe. Ratios of 2.0 or higher would be considered risky. If a company has a negative D/E ratio, this means that the company has negative shareholder equity. In other words, it means that the company has more liabilities than assets. This is considered a hazardous sign in most cases, indicating that the company may be at risk of bankruptcy.
The D/E ratio can also apply to personal financial statements, in which case it is also known as the personal D/E ratio. The personal D/E ratio is used when an individual or small business is applying for a loan. Lenders use the D/E to evaluate how likely it would be that the borrower can continue making loan payments if their income was temporarily disrupted.
Debt-To-Equity (D/E) Ratio Example
A prospective individual seeking a loan to buy a home out of a job for a few months is more likely to continue making payments if they have more assets than debt. This is also true for an individual applying for a small business loan or line of credit. If the business owner has an excellent personal D/E ratio, they are more likely to continue making loan payments while their business is growing.« Back to Glossary Index