Debt to Equity ratio

The debt to equity ratio is a financial, liquidity ratio that brings into comaprison, a company’s total debt to total equity. The debt to equity ratio indicates the percentage of financing of the company that is brought in from creditors and investors. A higher debt to equity ratio suggests that there is more utilisation of fincances from the creditor (bank loans) than the finances from investor (shareholders).

Formula to calculate Debt to Equity ratio

To calculate debt to equity ratio, total liabilities are divided by total equity. So, this gives us the formula:

Debt to Equity Ratio = Total Liabilities/Total Equity

Application of Debt to Equity ratio

Different industries have different debt to equity ratio benchmarks, as some industries prefer to utilise more debt financing than others. A debt ratio of .5 will indicate that there are half as many liabilities than there is equity. Simply put, the assets of the company are funded 2:1 by investors to creditors. This means that investors own 66.6 cents of every dollar of company assets while creditors only own 33.3 cents on the dollar.

Example

If a balance sheet shows a total debt of a business as $80 million and the total equity is worth $120 million, then debt-to-equity is 0.67. This suggests that for each dollar in equity, the firm has 67 cents in leverage. A ratio of 1 indicates that creditors and investors are equally involved in the company’s assets.

A higher debt-equity ratio indicates a levered firm, which is a good sign for companies that have stable and significant cash flow generation, but it can be a problem for a company that is in decline. Simply put, a lower ratio shows that a firm is less levered and mjorly financed by equity. The appropriate debt to equity ratio varies by industry.