Debt to Equity Ratio
The Debt to Equity Ratio is an extremely useful financial formula within the family of Leverage Ratios . This ratio takes two financial metrics found on your balance sheet — total debt and total equity — and divides them. This produces a number that measures the proportion of debt financing to equity financing within your company.
Debt to Equity Ratio Formula:
Debt to Equity Ratio = Total Debt / Total Equity
Total Debt: Total debt is calculated from your company’s balance sheet. It is all long-term loans and short-term liabilities added together.
Total equity: Total equity is calculated from your company’s balance sheet. It is liabilities subtracted from total assets.
Balance sheet: A core financial statement that records a snapshot of a company’s assets, liabilities, and equity at the time of publication. For more information about the balance sheet, read our helpful blog post !
What can the debt to equity ratio tell me about my business?
The debt to equity (D/E) ratio tells you your company’s balance of debt to equity financing. For example, with perfectly equal amounts of debt and equity, you’ll get a D/E ratio of exactly 1.
If the number is higher than one, your company has a greater percentage of debt financing than equity financing. The inverse, a decimal lower than one, indicates your company has a greater percentage of equity financing than debt financing.
A high D/E ratio is often associated with higher-risk financial situations, because it means that a company has been quite aggressive in financing its growth with debt. For example, a D/E ratio of 5 would mean your business is currently funded on five times as much debt as equity.
However, high leverage ratios aren’t necessarily risky in slow-growth industries where income stability and consistent debt payoff is guaranteed. What may look like a “high” D/E ratio in one industry is not necessarily the case across the board.
A lower D/E ratio (below 1) indicates a higher amount of equity funding. This is considered more financially stable and attractive to lenders, as it is usually proof of a more conservative and less risky business model.
Like our other financial ratios, however, average numbers can vary tremendously. Compare your D/E ratio with other companies of your size within your industry to get a sense of whether or not your D/E ratio is where you’d like it to be.