Debt-to-Equity Ratio

What is Debt-to-Equity Ratio?

A company’s debt-to-equity ratio, or D/E ratio, is a measure of the extent to which a company can cover its debt. It is calculated by dividing a company’s total debt by its total shareholders’ equity. The higher the D/E ratio, the more difficult it may be for the business to cover all of its liabilities.

For example: \$200,000 in debt/ \$100,000 in shareholders’ equity = 2 D/E ratio

A D/E can also be expressed as a percentage. In this example, a D/E of 2 also equals 200%. This means that for every \$1 of the company owned by shareholders, the business owes \$2 to creditors.

Since there are many ways to calculate the D/E ratio, it’s important to be clear about exactly which types of debt and equity are included in the calculation.

Types of Debt

A D/E ratio can include some or all of the following types of debt:

• Short-term liabilities
• Long-term liabilities
• Accounts payable
• Accrued liabilities
• Leases and other financing arrangements

What a D/E Means

A high D/E ratio generally means that in the case of a business downturn, a company could have difficulty paying off its debts. The higher the D/E, the riskier the business.

However, there are industries where a high D/E ratio is typical, such as in capital-intensive businesses that routinely invest in property, plant, and equipment as part of their operations. On the other hand, lifestyle or service businesses without a need for heavy machinery and workspace will more likely have a low D/E.

While lenders and investors generally prefer that a company maintain a low D/E ratio, a low D/E can also suggest that the company may not be leveraging its assets well, limiting its profitability.