Debt to Equity (DE) Ratio (2024)

What is Debt to Equity Ratio?

Debt to Equity Ratio, also called the gearing ratio, denotes how much debt a company uses relative to its equity. Debt to Equity Ratio signifies the proportion of the shareholder’s equity and the debt used to finance the firm’s assets.

You must check the company’s debt on its balance sheet before investing in its shares. It helps determine the company’s financial leverage. You get an idea of how much debt a company bears to finance its projects and expand the business.

The average Debt to Equity Ratio varies across industries. For instance, manufacturing companies tend to have relatively higher debt, whereas technology firms have lower debt on their balance sheets.

Capital Structure is a combination of debt and equity to finance a company’s operations. The Debt to Equity Ratio shows how a firm’s capital structure is tilted toward debt or equity.

Debt to Equity Ratio Formula:

Debt to Equity Ratio = Total Liabilities / Shareholders Equity

You may use an alternate calculation considering long-term debt instead of a company’s total debt. However, this is called the long-term debt to equity ratio.

Debt to Equity Ratio Calculations:

Suppose a Company XYZ Ltd. has total liabilities of Rs 3,000 crore. It has shareholders equity of Rs 15,000 crore. Using the Debt to Equity Ratio formula, you get:

Debt to Equity Ratio = 3,000 / 15,000 = 0.2.

Let’s have another example: Company ABC Ltd. has total liabilities of Rs 500 crore. It has shareholders equity of Rs 300 crore. Using the Debt to Equity Ratio formula, you get:

Debt to Equity Ratio = 500 / 300 = 1.66

Suppose the company increases the total debt by Rs 200 crore by taking a business loan. The new total debt is Rs 700 crore, and the shareholder’s equity remains at Rs 300 crore. Your Debt to Equity Ratio increases to 2.33.

The Debt to Equity Ratio tells you how much debt the company bears per Re 1 of Shareholders Equity.

What is the significance of the Debt to Equity Ratio?

  • The Debt to Equity Ratio helps you check a company’s financial health. You can also determine the company’s liquidity through this ratio.
  • You can understand if a company has high or low debt on its balance sheet. High debt may impact a company’s profitability and thereby its ability to issue dividends to its shareholders.
  • The Debt to Equity Ratio helps creditors determine if they should sanction loans to businesses.
  • A higher Debt to Equity Ratio may signify that a company poses significant risks to shareholders. It increases the chances of bankruptcy if the company’s profits go down.
  • A lower Debt to Equity Ratio signifies that a company focuses on a lower amount of debt to finance the business than equity financing. You could consider investing in shares of companies with a Debt to Equity Ratio of around 1.0 to 2.0.
  • Finally, Debt to Equity Ratio depends on the industry. It helps to select companies with Debt to Equity Ratios below 2.

Sometimes businesses have a negative Debt to Equity Ratio. It is because the company has a negative Shareholders’ Equity. Shareholder’s Equity is Assets minus Liabilities.

If liabilities are higher than assets, then shareholders’ equity is negative. Lenders and investors consider negative Debt to Equity Ratio as risky. It may indicate that the business may get bankrupt after some time.

Is there a direct connection between Debt to Equity Ratio and Return on Equity (ROE)?

Yes, there is a direct connection between Debt to Equity Ratio and ROE. For instance, if a company uses borrowed capital well, then a higher Debt to Equity ratio may lead to a higher ROE.

Lets understand this concept with an example:


Particulars

Company X

Company Y

Total Assets

Rs 2,00,000

Rs 2,00,000

Return on Assets (ROA)

12%

12%

Total Debt

Rs 80,000

Rs 90,000

Rate of Interest Payable on Debt

7%

7%

Leverage

2.50%

3%

Return on Equity

20%

24%

Both companies X and Y have the same assets and same return on assets. However, Company Y has a higher debt than Company X. Also, Company Y has a higher return on equity than Company X. It shows that Company Y has utilised debt well to generate a higher ROE.

What are the limitations of Debt to Equity Ratio?

  • If a company has a high Debt to Equity ratio, the cost of borrowing goes exceptionally high. The company may struggle to service its interest obligations which could drive down its share price.
  • The Debt to Equity ratio has many variations. You could struggle to compare the performance of two companies without adjusting their Debt to Equity ratio.
  • The Debt to Equity ratio may not be effective for companies with volatile share prices.

Conclusion:

  • A low Debt To Equity Ratio may signify a mature firm which has accumulated lots of money over time.
  • However, it may mean that a company is not utilising its resources optimally.
Debt to Equity (DE) Ratio (1)

Invest in Direct Mutual Funds

Save taxes upto Rs 46,800, 0% commission

Debt to Equity (DE) Ratio (2024)

FAQs

Debt to Equity (DE) 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.

What is an acceptable debt-to-equity ratio? ›

A good debt to equity ratio is around 1 to 1.5. However, the ideal debt to equity ratio will vary depending on the industry because some industries use more debt financing than others. Capital-intensive industries like the financial and manufacturing industries often have higher ratios that can be greater than 2.

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.

Is a debt-to-equity ratio of less than 1 good? ›

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.

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

If the company, for example, has a debt to equity ratio of . 50, it means that it uses 50 cents of debt financing for every $1 of equity financing. Firms whose ratio is greater than 1.0 use more debt in financing their operations than equity. If the ratio is less than 1.0, they use more equity than debt.

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.

Is 3.5 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.

Is 0.2 debt to equity good? ›

Generally, a good debt-to-equity ratio is anything lower than 1.0. A ratio of 2.0 or higher is usually considered risky. If a debt-to-equity ratio is negative, it means that the company has more liabilities than assets—this company would be considered extremely risky.

Is 0.7 a good debt-to-equity ratio? ›

The debt-to-equity ratio is calculated by dividing a corporation's total liabilities by its shareholder equity. The optimal D/E ratio varies by industry, but it should not be above a level of 2.0.

What does a debt-to-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.

Is a 50 debt-to-equity ratio good? ›

Yes, a D/E ratio of 50% or 0.5 is very good. This means it is a low-debt business and the company's equity is twice as high as its debts.

How to comment on 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 is the debt-to-equity ratio of Apple? ›

31, 2023.

What is too high for debt to ratio? ›

Key takeaways

Debt-to-income ratio is your monthly debt obligations compared to your gross monthly income (before taxes), expressed as a percentage. A good debt-to-income ratio is less than or equal to 36%. Any debt-to-income ratio above 43% is considered to be too much debt.

What if a firm has a debt-to-equity ratio of 1? ›

A ratio of 1 would imply that creditors and investors are on equal footing in the company's assets.

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

The debt-to-equity (D/E) ratio reflects a company's debt status. A high D/E ratio is considered risky for lenders and investors because it suggests that the company is financing a significant amount of its potential growth through borrowing.

Is 2.5 a good debt to equity ratio? ›

This is because total liabilities represents the numerator of the ratio. The more debt you have, the higher your ratio will be. A ratio of roughly 2 or 2.5 is considered good, but anything higher than that is considered unfavorable. A ratio between 5 and 7 enters the “high” zone.

Is a debt to equity ratio of 50% good? ›

Yes, a D/E ratio of 50% or 0.5 is very good. This means it is a low-debt business and the company's equity is twice as high as its debts.

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 a 40% debt to equity ratio good? ›

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.

Top Articles
Latest Posts
Article information

Author: Geoffrey Lueilwitz

Last Updated:

Views: 5705

Rating: 5 / 5 (80 voted)

Reviews: 95% of readers found this page helpful

Author information

Name: Geoffrey Lueilwitz

Birthday: 1997-03-23

Address: 74183 Thomas Course, Port Micheal, OK 55446-1529

Phone: +13408645881558

Job: Global Representative

Hobby: Sailing, Vehicle restoration, Rowing, Ghost hunting, Scrapbooking, Rugby, Board sports

Introduction: My name is Geoffrey Lueilwitz, I am a zealous, encouraging, sparkling, enchanting, graceful, faithful, nice person who loves writing and wants to share my knowledge and understanding with you.