Debt-to-equity ratio: Definition and calculation

What is the debt-to-equity ratio?

The debt-to-equity ratio (D/E) ratio is a key financial metric that compares a company’s total debt to its total shareholder equity. It offers a clear snapshot of the company’s financial leverage and capital structure.

Investors and private fund managers use the D/E ratio to determine how much of a company’s operations are financed by borrowed funds versus invested funds. This insight is crucial for making informed investment decisions and managing long-term financial stability.

High vs. low debt-to-equity ratio

Maintaining a good debt-to-equity ratio is crucial because it signals a company’s financial health and risk profile to investors and lenders. While debt-to-equity ratios can vary by industry, company size, and economic conditions, some general guidelines apply:

• Low D/E Ratio (<1.0): Indicates a conservative approach with greater reliance on equity financing. This carries a lower risk but can limit growth opportunities.

• Moderate D/E Ratio (1.0–2.0): Suggests balanced capital structure (amount of debt vs. equity), supporting sustainable growth while keeping financial risk in check.

• High D/E Ratio (>2.0): Implies a heavier reliance on debt financing, which is higher risk but more likely to generate returns.

Debt-to-equity ratio calculation

Calculating a company's debt-to-equity ratio is straightforward:

Debt-to-equity ratio = Total debt / Shareholder equity

Where:

• Total debt = Short-term debt + long-term debt

• Shareholder equity = Company’s assets – total liabilities

Information about a company’s total liabilities, total assets, and debt obligations can be found on its balance sheet.