Debt-to-Equity Ratio

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Definition

The debt-to-equity ratio (debt/equity ratio, D/E) is a financial ratio indicating the relative proportion of entity's equity and debt used to finance an entity's assets. This ratio is also known as financial leverage.

Debt-to-equity ratio is the key financial ratio and is used as a standard for judging a company's financial standing. It is also a measure of a company's ability to repay its obligations. When examining the health of a company, it is critical to pay attention to the debt/equity ratio. If the ratio is increasing, the company is being financed by creditors rather than from its own financial sources which may be a dangerous trend. Lenders and investors usually prefer low debt-to-equity ratios because their interests are better protected in the event of a business decline. Thus, companies with high debt-to-equity ratios may not be able to attract additional lending capital.

Calculation (formula)

A debt-to-equity ratio is calculated by taking the total liabilities and dividing it by the shareholders' equity:

Debt-to-equity ratio = Liabilities / Equity

Both variables are shown on the balance sheet (statement of financial position).

Norms and Limits

Optimal debt-to-equity ratio is considered to be about 1, i.e. liabilities = equity, but the ratio is very industry specific because it depends on the proportion of current and non-current assets. The more non-current the assets (as in the capital-intensive industries), the more equity is required to finance these long term investments.

For most companies the maximum acceptable debt-to-equity ratio is 1.5-2 and less. For large public companies the debt-to-equity ratio may be much more than 2, but for most small and medium companies it is not acceptable. US companies show the average debt-to-equity ratio at about 1.5 (it's typical for other countries too).

In general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations. However, a low debt-to-equity ratio may also indicate that a company is not taking advantage of the increased profits that financial leverage may bring.

Exact Formula in the ReadyRatios Analytical Software

Debt-to-equity ratio = F1[Liabilities] / F1[Equity]

F1 – Statement of financial position (IFRS)

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Quote Anees, 30 March, 2012
the above mentioned formula for Debt to equity ratio is incorrect.
The correct formula is

Long term Liabilites/(Long term liabilities + share holder equity)
Quote Vit. A., 30 March, 2012
Quote
Anees wrote:
the above mentioned formula for Debt to equity ratio is incorrect.
The correct formula is

Long term Liabilites/(Long term liabilities + share holder equity)
You are not right. Your formula is Capitalization Ratio formula.
Quote Guest, 19 November, 2012
Mr. Anees ur formula is for deriving long term debt .. and Long term liability + equity is the firm's capitalization which is concern for Financial Manager
Quote salem (jeje) wiseman, 20 February, 2013
in a corporation substitute the total amount of stockholders equity for the total amount of owners equity. the debt to equity ratio is an indicator of financial leverage the larger the ratio the more leverage therefore more risk.
Quote Nabeel, 23 March, 2013
There are two formullas to calculate debt to equity ratios.

-L.T Liabitilities/Sh. Holder Equity

-L.T Liabitilities/L.T Liabitilities+Sh. Holder Equity

Both formullas are right. The only difference is that when you will be commenting on the results that commenting would be a bit different. Moreover, depending on the structure of the organization, company decides which one of these ratios should be used.

Nabeel
Quote Guest, 27 April, 2013
L.T Liabitilities/Sh. Holder Equity = D/E= debt to equity ratio

L.T Liabitilities/L.T Liabitilities+Sh. Holder Equity=D/D+E=debt ratio
don't mix them up
Quote AndreP, 29 April, 2013
For more specific leverage, it should be:
all Interest bearing long term debt / share holder equity.
this will show how much the leverage in liabilities, because in total liabilities there is non-financial liabilities such as trade payable, deferred tax liabilities, etc.

LT liabilities / (LT liabilities + Shareholders equity) is formula for calculate Debt to Capital Ratio...

regards.
Quote Guest, 23 May, 2013
no one is sure what exact formulla is?
Quote sya, 3 June, 2013
formula debt-to-equity ratio is:

total debt
total equity

*as mentioned by my lecturer during the class.
Quote Guest, 5 June, 2013
"to pay off 100 rupee of debt how much you carry equity thereagainst"
is it translation to debt - equity ratio ???????

Plz suggest.
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