Debt to equity ratio: Calculating company risk (2024)

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  • A debt-to-equity ratio measures a company's financial leverage by comparing total liabilities to its shareholder equity.
  • A higher debt-to-equity ratio is often associated with risk, while lower ratios are considered safe.
  • Debt-to-equity ratio varies by industry; some like banking and financial services have higher ratios.

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A company's financial health can be evaluated using liquidity ratios such as the debt-to-equity (D/E) ratio, which compares total liabilities to total shareholder equity. A D/E ratio determines how much debt and equity a company uses to finance its operations.

The D/E ratio is arguably one of the most vital metrics to evaluate a company's financial leverage as it determines how much debt or equity a firm uses to finance its operations. When finding the D/E ratio of a company, it's vital to compare the ratios of other companies within the same industry for a better idea of how they're performing.

Here's how to analyze company risk with a debt-to-equity ratio works.


What is debt-to-equity ratio?

The debt-to-equity ratio (aka the debt-equity ratio) is a metric used to evaluate a company's financial leverage by comparing total debt to total shareholder's equity. In other words, it measures how much debt and equity a company uses to finance its operations.

Investors typically look at a company's balance sheet to understand the capital structure of a business and assess the risk. Trends in debt-to-equity ratios are monitored and identified by companies as part of their internal financial reporting and analysis.

"Interpreting debt-to-equity ratios is a bit of art mixed with a dash of science," says Robert R. Johnson, PhD, CFA, the founder of Economic Index Associates. " The higher the debt-to-equity ratio is, the greater proportion of a company's finances comes from debt."

In some cases, investors may prefer a higher D/E ratio when leverage is used to finance its growth, as a company can generate more earnings than it would have without debt financing. This is beneficial to investors if leverage generates more income than the cost of the debt. However, share values may fall when the debt's cost exceeds earnings.


A lower D/E ratio isn't necessarily a positive sign 一 it means a company relies on equity financing, which is more expensive than debt financing. Conservative investors may prefer companies with lower D/E ratios, especially if they pay dividends.

Calculating and interpreting the debt-to-equity ratio

Divide a company's total liabilities by shareholders' equity to calculate the debt-to-equity ratio. Here's the formula for calculating the debt-to-equity ratio:

Debt to equity ratio: Calculating company risk (4)

Total liabilities are combined obligations that a company owes other parties. These liabilities are typically broken down into three categories: short-term, long-term, and other.

Shareholders' equity (aka stockholders' equity) is the owner's residual claims on a company's assets after settling obligations. It also represents a firm's total assets less liabilities.


How to calculate debt-to-equity ratio in Excel

Excel's balance sheet template is an easy way to calculate a company's debt-to-equity ratio automatically. To calculate the D/E ratio, enter the value for total liabilities and shareholders' equity in adjacent cells, such as A2 and A3, then insert the formula "=A2/A3" in another cell.

What is a good debt-to-equity ratio?

D/E ratios vary by industry and can be misleading if used alone to assess a company's financial health. For this reason, using the D/E ratio, alongside other ratios and financial information, is key to getting the full picture of a firm's leverage.

"A good debt-to-equity ratio really depends on the business in question, both in regards to its own financial strategy and the industry it operates within," says Shaun Heng, director of product strategy at MoonPay. "Ratios over 2.0 are generally considered risky, whereas a ratio of 1.0 is considered safe."

However, that's not foolproof when determining a company's financial health. Some industries, like the banking and financial services sector, have relatively high D/E ratios and that doesn't mean the companies are in financial distress.


"Some industries are more stable, though, and can comfortably handle more debt than others can," says Johnson. "Industries that require large investment in equipment and those with stable cash flow 一 like electric utilities 一 tend to handle higher debt-to-equity ratios than those with less investment required, like software firms."

A D/E ratio close to zero can also be a negative sign as it indicates that the business isn't taking advantage of the potential growth it can gain from borrowing. Therefore, a "good" debt-to-equity ratio is generally about balance.

Debt-to-equity ratio example

Let's look at a real-life example of one of the leading tech companies by market cap, Apple, to find out its D/E ratio. Looking at the balance sheet for the 2023 fiscal year, Apple had total liabilities of $290 billion and total shareholders' equity of $62 billion.

Using the debt-to-equity formula, the D/E ratio of Apple is calculated by dividing $290 billion by $62 billion. The result is over 4.6, meaning that Apple used more than $4.60 of debt for every dollar of equity. While Apple has a relatively high D/E ratio often associated with risk, it doesn't mean it is experiencing financial distress. Some industries — such as tech, manufacturing, and banking — typically have higher D/E ratios than others.


Debt to equity ratio in decision making

Since a high debt-to-equity ratio is associated with increased risk, investors typically prefer businesses with low to moderate D/E ratios (1-2). Overleveraged companies might not appeal to potential investors due to the increased probability of bankruptcy.

A low D/E ratio indicates a decreased probability of bankruptcy if the economy takes a hit, making it more attractive to investors. However, a high D/E ratio isn't necessarily always bad, as it sometimes indicates an efficient use of capital. Or, a high D/E may be standard for the industry. Banks, for example, often have high debt-to-equity ratios since borrowing large amounts of money is standard practice and doesn't indicate mismanagement of funds.

Investors will also be discouraged by too low of a D/E ratio (<1). A ratio close to zero can be a sign that a company isn't taking advantage of the leverage of debt capital and the potential for accelerated growth and tax advantages.

Debt-to-equity ratio in different economic contexts

Economic factors such as economic downturns and interest rates affect a company's optimal debt-to-income ratio by industry.


Although it will increase their D/E ratios, companies are more likely to take on debt when interest rates are low to capitalize on growth potential and fund finance operations. Companies are less likely to take on new debt when high interest rates.

Businesses often experience decreased revenue during recessions, making it harder to fulfill debt obligations and thus raising the D/E ratio. Those that already have high D/E ratios are the most vulnerable to economic downturns. Even if the business isn't taking on new debt, declining profits can continue to raise the D/E ratio. On the bright side, this may prevent companies from over-leveraging.

Like start-ups, companies in the growth stage rely on debt to fund their operations and leverage growth potential. Although their D/E ratios will be high, it doesn't necessarily indicate that it is a risky business to invest in.

Debt to equity ratio — Frequently asked questions (FAQs)

What is considered a good debt-to-equity ratio?

A good debt-to-equity ratio is typically a low D/E ratio of less than 1. However, what is actually a "good" debt-to-equity ratio varies by industry, as some industries (like the finance industry) borrow large amounts of money as standard practice. On the other hand, businesses with D/E ratios too close to zero are also seen as not leveraging growth potential.

Can a company have a negative debt-to-equity ratio?

A company with a negative net worth can have a negative debt-to-equity ratio. A negative D/E ratio means that the total value of the company's assets is less than the total amount of debt and other liabilities. This indicates financial instability and the potential for bankruptcy. However, start-ups with a negative D/E ratio aren't always cause for concern.

How does debt-to-equity ratio differ from debt-to-asset ratio?

Debt-to-equity and debt-to-asset ratios are used to measure a company's risk profile. The debt-to-equity ratio measures how much debt and equity a company uses to finance its operations. The debt-to-asset ratio measures how much of a company's assets are financed by debt. With debt-to-equity ratios and debt-to-assets ratios, lower is generally favored, but the ideal can vary by industry.

Is a high debt-to-equity ratio always bad?

A high-debt-to-equity ratio isn't bad but is often a sign of higher risk. Some industries like finance, utilities, and telecommunications normally have higher leverage due to the high capital investment required.

How frequently should a company analyze its debt-to-equity ratio?

How frequently a company should analyze its debt-to-equity ratio varies from company to company, but generally, companies report D/E ratios in their quarterly and annual financial statements. They may monitor D/E ratios more frequently, even monthly, to identify potential trends or issues.

Lydia Kibet

Lydia Kibet is a freelance writer with a knack for personal finance, investing, and all things money. She's passionate about explaining complex topics in easy-to-understand language. Her work has appeared in Business Insider, Investopedia, The Motley Fool, and GoBankingRates. She currently writes about personal finance, insurance, banking, real estate, mortgages, credit cards, loans, and more. Connect with her atlydiakibet.comorLinkedIn.

Tessa Campbell

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Tessa Campbell is a Junior Investing Reporter for Personal Finance Insider. She reports on investing-related topics like cryptocurrency, the stock market, and retirement savings accounts. She originally joined the PFI team as a Personal Finance Reviews Fellow in 2022.Her love of books, research, crochet, and coffee enriches her day-to-day life.

Debt to equity ratio: Calculating company risk (2024)


Debt to equity ratio: Calculating company risk? ›

"A good debt-to-equity ratio really depends on the business in question, both in regards to its own financial strategy and the industry it operates within," says Shaun Heng, director of product strategy at MoonPay. "Ratios over 2.0 are generally considered risky, whereas a ratio of 1.0 is considered safe."

How is the debt-to-equity ratio measures a company's risk and is calculated? ›

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.

How does debt-to-equity ratio determine financial risk? ›

The debt-to-equity ratio often is associated with risk: A higher ratio suggests higher risk and that the company is financing its growth with debt. However, when a company is in its growth phase, a high D/E ratio might be necessary for that growth.

What does a company's debt-to-equity ratio tell you? ›

The debt-to-equity ratio (D/E ratio) shows how much debt a company has compared to its assets. It is found by dividing a company's total debt by total shareholder equity. A higher D/E ratio means the company may have a harder time covering its liabilities. A D/E can also be expressed as a percentage.

What is a safe range for debt-to-equity ratio? ›

The ideal debt to equity ratio is 2:1. This means that at no given point of time should the debt be more than twice the equity because it becomes riskier to pay back and hence there is a fear of bankruptcy.

Does debt-to-equity ratio measure profitability? ›

No. Debt equity is a balance sheet ratio simply because both the elements I.e debt and equity are taken from the Balance sheet. Profitability ratios include EBITDA margins, PAT margins, etc.

Why is debt ratio a good indicator of risk? ›

If a company has a negative debt ratio, this would mean that the company has negative shareholder equity. In other words, the company's liabilities outnumber its assets. In most cases, this is considered a very risky sign, indicating that the company may be at risk of bankruptcy.

Does a higher debt ratio mean more risk? ›

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.

Why is a high debt-to-equity ratio risky? ›

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.

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