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

The debt-to-equity (D/E) ratio is used to evaluate a 澳洲幸运5官方开奖结果体彩网:company’s financial leverage. It's calculated by dividing a company’s total liabilities by its shareholder equity. The D/E ratio is an important metric in corporate finance because it's a measure of the degree to which a company is financiꦦng its operations with debt rather than its own resources.

The debt-to-equity ratio is a type of 澳洲幸运5官方开奖结果体彩网:gearing ratio.

Calculation of the D/E Ratio

$\begin{aligned} &\text{Debt/Equity} = \frac{ \text{Total Liabilities} }{ \text{Total Shareholders' Equity} } \\ \end{aligned}$​Debt/Equity=Total Shareholders’ EquityTotal Liabilities​​

The necessary information to calculate the D/E ratio can be found on a company’s balance sheet. Subtracting the value of liabilities from total assets shown there provides the figure for 澳洲幸运5官方开奖结果体彩网:shareholder equity.

These balance sheet categories may include items that wouldn't normally be considered debt or equity in the traditional sense of a loan or an asset. The ratio can be distorted by 澳洲幸运5官方开奖结果体彩网:retained earnings or losses, intangible assets, and pension plan adjustments so further research is usually needed to understꦉand to what extent a company relies on debt.

Analysts and investors will often modify the D/E ratio to get a clearer picture and facilitate comparisons. They also assess the D/E ratio in the context of short-term 澳洲幸运5官方开奖结果体彩网:leverage ratios, profitability, and growth expectations.

Calculating 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 澳洲幸运5官方开奖结果体彩网:debt ratio.

Your other option is to enter the values for total liabilities and shareholders’ equity in adjacent spreadsheet cells such as in B2 and B3 and 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 liabiliti𒁏es. Debt must be repaid or refinanced🅘 and it imposes interest expenses that typically can’t be deferred. This can impair or destroy the value of equity in the event of a default. A high D/E ratio is often associated with high investment risk as a result. It means that a company relies primarily on debt financing.

Debt-financed growth can increase earnings and shareholders should expect to benefit if the incremental profit increase exceeds the related rise in debt service costs. The share price may drop, however, if the additional cost of debt financing outweighs the additional income it generates. 🌜Tꦆhe cost of debt and a company’s ability to service it can vary with market conditions. Borrowing that seemed prudent at first can prove unprofitable later as a result.

Changes in long-term debt and assets tend to affect the D/E ratio the most because the numbers tend to be larger than for short-term debt and short-term assets. Investors can use other ra๊tios if they 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.

The 澳洲幸运5官方开奖结果体彩网:cash ratio evaluates a company’s near-term liquidity:

$\begin{aligned} &\text{Cash Ratio} = \frac{ \text{Cash} + \text{Marketable Securities} }{ \text{Short-Term Liabilities } } \\ \end{aligned}$​Cash Ratio=Short-Term Liabilities Cash+Marketable Securities​​

The 澳洲幸运5官方开奖结果体彩网:current ratio does the same:

$\begin{aligned} &\text{Current Ratio} = \frac{ \text{Short-Term Assets} }{ \text{Short-Term Liabilities } } \\ \end{aligned}$​Current Ratio=Short-Term Liabilities Short-Term Assets​​

Example of the D/E Ratio

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

Using the above formu🍸la, the D/E ratio for Aꦚpple can be calculated as:

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

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

Modifying the D/E Ratio

The long-term 𒁃D/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 but these liabilities must be paid in a year or less so they're not as risky. Imagine a company with $1 million in short-term payables such as wages, accounts payable, and notes and $50ಌ0,000 in long-term debt. Compare this with a company with $500,000 in short-term payables and $1 million in long-term debt.

They would both have a D/E ratio of 1 if both companies had $1.5 million in shareholder equity. The risk from leverage is identical on th♉e surface but the second company is riskier in reality.

Short-term debt tends to be cheaper than long-term debt as a rule and it's less sensitive to shifts in interest rates. The second company’s interest expense and 澳洲幸运5官方开奖结果体彩网:cost of capital are therefore likely higher. Interest expense will rise if interest 💜rates are higher when the long-term debt comes due and has to be refinanced.

Debt due sooner shouldn’t be a concern if we assume that the company won't default over the next year. 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 澳洲幸运5官方开奖结果体彩网:personal financial statements as well, serving as a personal D/E ratio. Equity refers to the difference between the total value of an individual’s assets and their aggregate debt or liabilities in th🐟is case. The formula for the personal D/E ratio is slightly different:

$\begin{aligned} &\text{Debt/Equity} = \frac{ \text{Total Personal Liabilities} }{ \text{Personal Assets} - \text{Liabilities} } \\ \end{aligned}$​Debt/Equity=Personal Assets−LiabilitiesTotal Personal Liabilities​​

The personal D/E ratio is often used when an individual or a small business is applying for a loan. Lende🅰rs 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.

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 who's applying for a 澳洲幸运5官方开奖结果体彩网:small business loan or a 澳洲幸运5官方开奖结果体彩网:line of credit.

It's more likely that they can continue making loan payments until their debt-fi🌼nanced investment starts paying off ♓if a business owner has a good personal D/E ratio.

D/E Ratio vs. Gearing Ratio

Gearing ratios constitute a broad category of financial ratios. The D/E ratio is the best💖 known of them.✨ “Gearing” is a term for financial leverage.

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

Limitations of the D/E Ratio

It's very important to consider the industry in which the company operates when using the D/E ratio. Different industries have different capital needs and growth rates so 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. It's a highly regulated industry that makes large investments typically at a stable rate of return, generating a steady income stream, so 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 aren't always consistent about what is defined as debt. 澳洲幸运5官方开奖结果体彩网:Preferred stock is sometimes considered equity because 澳洲幸运5官方开奖结果体彩网:preferred dividend payments aren't legal obligations and preferred shares rank below all other debt but above common stock in the priority of their claim on corporate assets. The typically steady preferred dividend, 澳洲幸运5官方开奖结果体彩网:par value, and 澳洲幸运5官方开奖结果体彩网: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 it 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 that are notably reliant on preferred stock financing such as 澳洲幸运5官方开奖结ꦺ果体彩网:real estate investment trusts 🦹(REITs).

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 its comp🃏etitors to gain a sense of a company’s reliance on debt. Not all high D/E ratios signal poor business prospects, however.

Debt can enable the company to grow and generate additional income but potential i♓nvestors will want to investigat﷽e further if a company has grown increasingly reliant on debt or inordinately so for its industry.