Debt-to-Equity (D/E) Ratio Formula and How to Interpret It (2024)

What Is the Debt-to-Equity (D/E) Ratio?

The debt-to-equity (D/E) ratio is used to evaluate a company’s financial leverage and is calculated by dividing a company’s total liabilities by its shareholder equity. The D/E ratio is an important metric in corporate finance. It is a measure of the degree to which a company is financing its operations with debt rather than its own resources. The debt-to-equity ratio is a particular type of gearing ratio.

Key Takeaways

  • The debt-to-equity (D/E) ratio compares a company’s total liabilities with its shareholder equity and can be used to assess the extent of its reliance on debt.
  • D/E ratios vary by industry and are best used to compare direct competitors or to measure change in the company’s reliance on debt over time.
  • Among similar companies, a higher D/E ratio suggests more risk, while a particularly low one may indicate that a business is not taking advantage of debt financing to expand.
  • Investors will often modify the D/E ratio to consider only long-term debt because it carries more risk than short-term obligations.

Debt-to-Equity (D/E) Ratio Formula and How to Interpret It (1)

Formula and Calculation of the D/E Ratio

Debt/Equity=TotalLiabilitiesTotalShareholders’Equity\begin{aligned} &\text{Debt/Equity} = \frac{ \text{Total Liabilities} }{ \text{Total Shareholders' Equity} } \\ \end{aligned}Debt/Equity=TotalShareholders’EquityTotalLiabilities

The information needed to calculate the D/E ratio can be found on a listed company’s balance sheet. Subtracting the value of liabilities on the balance sheet from that of total assets shown there provides the figure for shareholder equity, which is a rearranged version of this balance sheet equation:

Assets=Liabilities+ShareholderEquity\begin{aligned} &\text{Assets} = \text{Liabilities} + \text{Shareholder Equity} \\ \end{aligned}Assets=Liabilities+ShareholderEquity

These balance sheet categories may include items that would not normally be considered debt or equity in the traditional sense of a loan or an asset. Because the ratio can be distorted by retained earnings or losses, intangible assets, and pension plan adjustments, further research is usually needed to understand to what extent a company relies on debt.

To get a clearer picture and facilitate comparisons, analysts and investors will often modify the D/E ratio. They also assess the D/E ratio in the context of short-term leverage ratios, profitability, and growth expectations.

Debt-to-Equity (D/E) Ratio Formula and How to Interpret It (2)

How to Calculate the D/E Ratio in Excel

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 the debt ratio.

Or you could enter the values for total liabilities and shareholders’ equity in adjacent spreadsheet cells, say B2 and B3, then add the formula “=B2/B3” in cell B4 to obtain the D/E ratio.

What Does the D/E Ratio Tell You?

The D/E ratio measures how much debt a company has taken on relative to the value of its assets net of liabilities. Debt must be repaid or refinanced, imposes interest expense that typically can’t be deferred, and could impair or destroy the value of equity in the event of a default. As a result, a high D/E ratio is often associated with high investment risk; it means that a company relies primarily on debt financing.

Debt-financed growth may serve to increase earnings, and if the incremental profit increase exceeds the related rise in debt service costs, then shareholders should expect to benefit. However, if the additional cost of debt financing outweighs the additional income that it generates, then the share price may drop. The cost of debt and a company’s ability to service it can vary with market conditions. As a result, borrowing that seemed prudent at first can prove unprofitable later under different circ*mstances.

Changes in long-term debt and assets tend to affect the D/E ratio the most because the numbers involved tend to be larger than for short-term debt and short-term assets. If investors want to evaluate a company’s short-term leverage and its ability to meet debt obligations that must be paid over a year or less, they can use other ratios.

For example, the cash ratio evaluates a company’s near-term liquidity:

CashRatio=Cash+MarketableSecuritiesShort-TermLiabilities\begin{aligned} &\text{Cash Ratio} = \frac{ \text{Cash} + \text{Marketable Securities} }{ \text{Short-Term Liabilities } } \\ \end{aligned}CashRatio=Short-TermLiabilitiesCash+MarketableSecurities

So does the current ratio:

CurrentRatio=Short-TermAssetsShort-TermLiabilities\begin{aligned} &\text{Current Ratio} = \frac{ \text{Short-Term Assets} }{ \text{Short-Term Liabilities } } \\ \end{aligned}CurrentRatio=Short-TermLiabilitiesShort-TermAssets

Example of the D/E Ratio

Let’s consider an example from Apple Inc. (AAPL). We can see below that for Q1 2024, ending Dec. 30, 2023, Apple had total liabilities of $279 billion and total shareholders’ equity of $74 billion.

Debt-to-Equity (D/E) Ratio Formula and How to Interpret It (3)

Using the above formula, the D/E ratio for Apple can be calculated as:

Debt-to-equity = $279 Billion / $74 Billion = 3.77

The resultmeans that Applehad$3.77of debt for every dollar of equity. But on its own, the ratio doesn’t give investors the complete picture. It’s important to compare the ratio with that of other similar companies.

Modifying the D/E Ratio

Not all debt is equally risky. The long-term D/E ratio focuses on riskier long-term debt by using its value instead of that of total liabilities in the numerator of the standard formula:

Long-term D/E ratio = Long-term debt ÷ Shareholder equity

Short-term debt also increases a company’s leverage, of course, but because these liabilities must be paid in a year or less, they aren’t as risky. For example, imagine a company with $1 million in short-term payables (wages, accounts payable, notes, etc.) and $500,000 in long-term debt, compared with a company with $500,000 in short-term payables and $1 million in long-term debt.

If both companies have $1.5 million in shareholder equity, then they both have a D/E ratio of 1. On the surface, the risk from leverage is identical, but in reality, the second company is riskier.

As a rule, short-term debt tends to be cheaper than long-term debt and is less sensitive to shifts in interest rates, meaning that the second company’s interest expense and cost of capital are likely higher. If interest rates are higher when the long-term debt comes due and needs to be refinanced, then interest expense will rise.

Finally, if we assume that the company will not default over the next year, then debt due sooner shouldn’t be a concern. In contrast, a company’s ability to service long-term debt will depend on its long-term business prospects, which are less certain.

The D/E Ratio for Personal Finances

The D/E ratio can apply to personal financial statements as well, serving as a personal D/E ratio. Here, equity refers to the difference between the total value of an individual’s assets and their aggregate debt, or liabilities. The formula for the personal D/E ratio is slightly different:

Debt/Equity=TotalPersonalLiabilitiesPersonalAssetsLiabilities\begin{aligned} &\text{Debt/Equity} = \frac{ \text{Total Personal Liabilities} }{ \text{Personal Assets} - \text{Liabilities} } \\ \end{aligned}Debt/Equity=PersonalAssetsLiabilitiesTotalPersonalLiabilities

The personal D/E ratio is often used when an individual or a small business is applying for a loan. Lenders use the D/E figure to assess a loan applicant’s ability to continue making loan payments in the event of a temporary loss of income.

For example, a prospective mortgage borrower is more likely to be able to continue making payments during a period of extended unemployment if they have more assets than debt. This is also true for an individual applying for a small business loan or a line of credit.

If the business owner has a good personal D/E ratio, it is more likely that they can continue making loan payments until their debt-financed investment starts paying off.

D/E Ratio vs. Gearing Ratio

Gearing ratios constitute a broad category of financial ratios, of which the D/E ratio is the best known. “Gearing” is a term for financial leverage.

Gearing ratios focus more heavily on the concept of leverage than other ratios used in accounting or investment analysis. The underlying principle generally assumes that some leverage is good, but that too much places an organization at risk.

The debt-to-equity ratio is most useful when used to compare direct competitors. If a company’s D/E ratio significantly exceeds those of others in its industry, then its stock could be more risky.

Limitations of the D/E Ratio

When using the D/E ratio, it is very important to consider the industry in which the company operates. Because different industries have different capital needs and growth rates, a D/E ratio value that’s common in one industry might be a red flag in another.

Utility stocks often have especially high D/E ratios. As a highly regulated industry making large investments typically at a stable rate of return and generating a steady income stream, utilities borrow heavily and relatively cheaply. High leverage ratios in slow-growth industries with stable income represent an efficient use of capital. Companies in the consumer staples sector tend to have high D/E ratios for similar reasons.

Analysts are not always consistent about what is defined as debt. For example, preferred stock is sometimes considered equity, since preferred dividend payments are not legal obligations, and preferred shares rank below all debt (but above common stock) in the priority of their claim on corporate assets. On the other hand, the typically steady preferred dividend, par value, and liquidation rights make preferred shares look more like debt.

Including preferred stock in total debt will increase the D/E ratio and make a company look riskier. Including preferred stock in the equity portion of the D/E ratio will increase the denominator and lower the ratio. This is a particularly thorny issue in analyzing industries notably reliant on preferred stock financing, such as real estate investment trusts (REITs).

What Is a Good Debt-to-Equity (D/E) 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 would be seen as relatively safe, whereas values of 2 or higher might be considered risky. Companies in some industries, such as utilities, consumer staples, and banking, typically have relatively high D/E ratios.

Note that a particularly low D/E ratio may be a negative, suggesting that the company is not taking advantage of debt financing and its tax advantages. (Business interest expense is usually tax deductible, while dividend payments are subject to corporate and personal income tax.)

What Does a D/E Ratio of 1.5 Indicate?

A D/E ratio of 1.5 would indicate that the company in question has $1.50 of debt for every $1 of equity. To illustrate, suppose the company had assets of $2 million and liabilities of $1.2 million. Because equity is equal to assets minus liabilities, the company’s equity would be $800,000. Its D/E ratio would therefore be $1.2 million divided by $800,000, or 1.5.

What Does a Negative D/E Ratio Signal?

If a company has a negative D/E ratio, this means that it has negative shareholder equity. In other words, the company’s liabilities exceed its assets. In most cases, this would be considered a sign of high risk and an incentive to seek bankruptcy protection.

What Industries Have High D/E Ratios?

In the banking and financial services sector, a relatively high D/E ratio is commonplace. Banks carry higher amounts of debt because they own substantial fixed assets in the form of branch networks. Higher D/E ratios can also tend to predominate in other capital-intensive sectors heavily reliant on debt financing, such as airlines and industrials.

How Can the D/E Ratio Be Used to Measure a Company’s Riskiness?

A steadily rising D/E ratio may make it harder for a company to obtain financing in the future. The growing reliance on debt could eventually lead to difficulties in servicing the company’s current loan obligations. Very high D/E ratios may eventually result in a loan default or bankruptcy.

The Bottom Line

The debt-to-equity (D/E) ratio can help investors identify highly leveraged companies that may pose risks during business downturns. Investors can compare a company’s D/E ratio with the average for its industry and those of competitors to gain a sense of a company’s reliance on debt. However, not all high D/Eratios signal poor business prospects.

In fact, debt canenable the company to grow and generate additional income. But if a company has grown increasingly reliant on debt or inordinately so for its industry, potential investors will want to investigate further.

Debt-to-Equity (D/E) Ratio Formula and How to Interpret It (2024)


Debt-to-Equity (D/E) Ratio Formula and How to Interpret It? ›

The formula for calculating the debt-to-equity ratio is to take a company's total liabilities and divide them by its total shareholders' equity. A good debt-to-equity ratio is generally below 2.0 for most companies and industries.

How to interpret the debt-to-equity ratio? ›

A high debt-to-equity ratio indicates that a company is borrowing more capital from the market to fund its operations, while a low debt-to-equity ratio means that the company is utilizing its assets and borrowing less money from the market. Capital industries generally have a higher debt-to-equity ratio.

What does a 1.5 debt-to-equity ratio mean? ›

A debt-to-equity ratio of 1.5 would indicate that the company in question has $1.50 of debt for every $1 of equity. To illustrate, suppose the company had assets of $2 million and liabilities of $1.2 million. Since equity is equal to assets minus liabilities, the company's equity would be $800,000.

What is a good d/e ratio? ›

Generally, a good debt-to-equity ratio is less than 1.0, while a risky debt-to-equity ratio is greater than 2.0. But this is relative—there are some industries in which companies regularly leverage more debt.

What does a debt-to-equity ratio of 1.25 mean? ›

= 1.25. With a long-term debt-to-equity ratio of 1.25, Company A uses $1.25 of long-term leverage for every $1.00 of equity.

Is 0.5 a good debt-to-equity ratio? ›

Generally, a lower ratio is better, as it implies that the company is in less debt and is less risky for lenders and investors. A debt-to-equity ratio of 0.5 or below is considered good.

What if the debt-to-equity ratio is more than 1? ›

A ratio greater than 1 implies that the majority of the assets are funded through debt. A ratio less than 1 implies that the assets are financed mainly through equity. A lower debt to equity ratio means the company primarily relies on wholly-owned funds to leverage its finances.

Is 2.5 a good debt-to-equity ratio? ›

Although it varies from industry to industry, a debt-to-equity ratio of around 2 or 2.5 is generally considered good. This ratio tells us that for every dollar invested in the company, about 66 cents come from debt, while the other 33 cents come from the company's equity.

Is a debt-to-equity ratio of 0.75 good? ›

Good debt-to-equity ratio for businesses

Many investors prefer a company's debt-to-equity ratio to stay below 2—that is, they believe it is important for a company's debts to be only double their equity at most. Some investors are more comfortable investing when a company's debt-to-equity ratio doesn't exceed 1 to 1.5.

What does a debt-to-equity ratio of 2.5 mean? ›

The ratio is the number of times debt is to equity. Therefore, if a financial corporation's ratio is 2.5 it means that the debt outstanding is 2.5 times larger than their equity. Higher debt can result in volatile earnings due to additional interest expense as well as increased vulnerability to business downturns.

What does debt-equity ratio of 0.4 mean? ›

Most lenders hesitate to lend to someone with a debt to equity/asset ratio over 40%. Over 40% is considered a bad debt equity ratio for banks. Similarly, a good debt to asset ratio typically falls below 0.4 or 40%. This means that your total debt is less than 40% of your total assets.

What is a bad debt-to-equity ratio? ›

The optimal debt-to-equity ratio will tend to vary widely by industry, but the general consensus is that it should not be above a level of 2.0. While some very large companies in fixed asset-heavy industries (such as mining or manufacturing) may have ratios higher than 2, these are the exception rather than the rule.

Is debt-to-equity of 0 good? ›

While this may sound like an attractive financial position, it's not necessarily always good. On the positive side, a zero debt-to-equity ratio can mean that a company has a strong financial position, is not burdened with debt payments, and has greater flexibility in its financial management.

Is 0.1 a good debt-to-equity ratio? ›

Debt-to-equity ratio values tend to land between 0.1 (almost no debt relative to equity) and 0.9 (very high levels of debt relative to equity). Most companies aim for a ratio between these two extremes, both for reasons of economic sustainability and to attract investors or lenders.

Is 0.25 a good debt-to-equity ratio? ›

Having said that, most experts believe a D/E ratio between 1.5 to 2.5 shows the company is financially stable. Taking the above examples, a D/E ratio of 0.25 is very good as it shows that the company is mostly funded by equity assets and has low obligations to repay.

Is 0.4 debt-to-equity ratio good? ›

In general, many investors look for a company to have a debt ratio between 0.3 and 0.6. From a pure risk perspective, debt ratios of 0.4 or lower are considered better, while a debt ratio of 0.6 or higher makes it more difficult to borrow money.

Is 2 a good debt-to-equity ratio? ›

The optimal debt-to-equity ratio will tend to vary widely by industry, but the general consensus is that it should not be above a level of 2.0. While some very large companies in fixed asset-heavy industries (such as mining or manufacturing) may have ratios higher than 2, these are the exception rather than the rule.

What does 1.2 debt-to-equity ratio mean? ›

Debt to equity ratio = 1.2. With a debt to equity ratio of 1.2, investing is less risky for the lenders because the business is not highly leveraged — meaning it isn't primarily financed with debt.

What does a debt-to-equity ratio of 1.75 mean? ›

D e b t t o E q u i t y r a t i o = T o t a l l i a b i l i t i e s T o t a l E q u i t y. A value of $1.75, therefore, indicates that for every dollar of equity, a firm uses $1.75 in debt to finance its assets. This ratio indicates that the business has more credit financing than the owner's financing.

What does a 1.0 debt-to-equity ratio mean? ›

A debt-to-equity ratio of 1.0 means that for every dollar of equity a company has, it uses $1 of debt to run the business. A debt-to-equity ratio of 2.0 means that for every $1 of equity a company has, it taps into $2 of financing. A debt-to-equity ratio of 0.75 equates to 75 cents borrowed for every $1 of equity.

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