The debt to equity ratio compares a company’s total debt to total equity. The debt to equity ratio shows the percentage of company financing that comes from creditors and investors. A higher debt to equity ratio indicates that more creditor financing (bank loans) is used than investor financing (shareholders).
The debt to equity ratio is calculated by dividing total liabilities by total equity.
Debt to Equity = Total Liabilities / Total Equity
Investors like a lower debt to equity ratio because it suggests a more financially stable business. A debt to equity ratio of 0.5 means that there are half as many liabilities than there is equity. In other words, the assets of the company are funded 2-to-1 by investors to creditors. This means that investors own 66.6 cents of every dollar of company assets while creditors only own 33.3 cents on the dollar. A debt to equity ratio of 2.0 means that there are twice as many liabilities than there is equity. This means that for every $1 of Company ABC owned by the shareholders, Company ABC owes $2 to creditors.
Companies with a higher debt to equity ratio are considered more risky to creditors and investors than companies with a lower ratio. Companies leveraging large amounts of debt might not be able to make the payments.<< Back to Glossary Index