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Debt to Equity Ratio

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Examples

Example:
Calculate D/E for Saving Face Beauty Salons, when:

  • Total liabilities = $3,423,000
  • Shareholders' equity = $5,493,000.
  • Debt-to-equity ratio = total liabilities ÷ shareholders' equity = $3,423,000÷ $5,493,000 = 0.62

Overview

A company’s debt-to-equity ratio measures where a company’s money is coming from. That is, it compares the financial value of assets financed by borrowing (debt) and assets financed by shareholder investment (equity).

As with other financial ratios, the D/E ratio is a measure of risk. The ratio value addresses concerns of investors and creditors that the assets generated by more debt might be less than costs of the debt (interest). The concern is that ultimately, the company might not be able to handle the costs, and the company can go bankrupt, leaving investors with nothing. The debt and equity values are often taken from the firm's balance sheet or statement of financial position.

Analysis

Investors and creditors view lower D/E values favorably because they indicate relatively less financing through lending and therefore lower investment risk.

A D/E value of 1.00 indicates that half of the assets of a business are financed by debts and half by shareholders' equity. A value higher than 1.00 means that more assets are financed by debt that those financed by money of shareholders. An increasing trend in of debt-to-equity ratio can indicate problems because it means that the percentage of assets financed by debt is increasing.

The significance of specific debt-to-equity ratio values depends on the industry in which companies operate. For example, capital-intensive industries such as auto manufacturing tend to have a D/E ratio above 2, while personal computer companies tend to have D/E values less than 0.5.