You really don’t need leverage in this world much. If you’re smart, you’re going to make a lot of money without borrowing. – Warren Buffett
What is the debt-to-equity ratio?
Measures the extent to which is debt used in relation to equity.
How is the debt-to-equity ratio calculated?
Debt-to-Equity ratio = total debt / total equity. Total debt includes all debts owed by a business; total equity is the balance remaining after liabilities have been deducted from total assets.
What does the debt-to-equity ratio mean to my business?
The lower the equity ratio is the greater the reliance on debt to finance the business and the greater the financial risk. The higher the ratio the opposite is true. Going even deeper, a ratio that is equal to or greater than one means that there is at least as much equity as debt. A ratio that is between one and zero means that there is more debt than equity. A ratio that is negative means that the business is in deficit (or has negative equity), meaning that it is fully financed by debt.
The use of debt is not always a negative and used responsibly can fuel a business’s growth. This ratio used in conjunction with other financial ratios can help determine how effectively debt is being used to finance operations.
Negatives to the debt-to-equity ratio:
The debt-to-equity ratio expresses the extent to which debt is used compared to equity for financing a business’s operations and growth. Much like other ratios, viewing this in isolation is not informative. The effective use of equity can be determined by analyzing return on equity. The effective use of debt can be determined by analyzing the interest coverage ratio.