Debt-to-Equity Ratio: Formula, Analysis and Examples

Liabilities are items or money the company owes, such as mortgages, loans, etc. In addition, the reluctance to raise debt can cause the company to miss out on growth opportunities to fund expansion plans, as well as not benefit from the “tax shield” from interest expense. Investors may check it quarterly in line with financial reporting, while business owners might track it more regularly. Currency fluctuations can affect the ratio for companies operating in multiple countries. It’s advisable to consider currency-adjusted figures for a more accurate assessment. InvestingPro offers detailed insights into companies’ Debt to Equity including sector benchmarks and competitor analysis.

• In addition, the reluctance to raise debt can cause the company to miss out on growth opportunities to fund expansion plans, as well as not benefit from the “tax shield” from interest expense.
• The D/E ratio contains some ambiguity because a healthy D/E ratio often falls within a range.
• In financial analysis, the debt-to-equity ratio (D/E ratio or “gearing” as it is known in the UK) is an important financial risk metric that provides valuable insights into a company’s financial health.
• The ratio fails to quantify the extent to which a company comfortably meets its current debt obligations.

You can find the balance sheet on a company’s 10-K filing, which is required by the US Securities and Exchange Commission (SEC) for all publicly traded companies. Determining whether a company’s ratio is good or bad means considering other factors in conjunction with the ratio. On the other hand, a comparatively low D/E ratio may indicate that the company is not taking full advantage of the growth that can be accessed via debt.

What Does the D/E Ratio Tell You?

In our debt-to-equity ratio (D/E) modeling exercise, we’ll forecast a hypothetical company’s balance sheet for five years. While not a regular occurrence, it is possible for a company to have a negative D/E ratio, which means the company’s shareholders’ equity balance has turned negative. Yes, the ratio doesn’t consider the quality of debt or equity, such as interest rates or equity dilution terms.

A significantly low ratio may, however, also be found in companies that reluctant to take the advantage of debt financing for growth. It represents the company’s capital structure and is evaluated by dividing its debts by shareholders’ equity. We need to provide the two inputs of total liabilities and the total shareholders’ equity.

Examples and Case Studies for Debt-to-Equity Ratio

However, the optimal debt to equity ratio in fundamental analysis will vary by industry – for example, capital-intensive industries such as utilities can sustainably operate with ratios of 2 or 3. A lower debt to equity ratio is seen as more financially stable, but some debt can be beneficial to boost returns on equity. The ideal ratio depends on each company’s specific risk profile, capital structure, and industry dynamics.

How to calculate the debt-to-equity ratio

Although it will increase their D/E ratios, companies are more likely to take on debt when interest rates are low to capitalize on growth potential and fund finance operations. Let’s look at a real-life example of one of the leading companies by market cap, Apple, to find out its D/E ratio. Looking at the balance sheet for the 2024 fiscal year, Apple had total liabilities of about $308 billion and total shareholders’ equity of around $57 billion. “Some industries are more stable, though, and can comfortably handle more debt than others can,” says Johnson. Here’s how a debt-to-equity ratio works and how to analyze company risk using this financial leverage ratio.

This could indicate financial instability and the potential for bankruptcy. However, some companies like startups with a negative D/E ratio aren’t always cause for concern, as it could take time to build equity that improves the D/E ratio. A low D/E ratio indicates a decreased probability of bankruptcy if the economy takes a hit, making it more attractive to investors. However, a high D/E ratio isn’t necessarily always bad, as it sometimes indicates an efficient use of capital. Banks, for example, often have high debt-to-equity ratios since borrowing large amounts of money is standard practice and doesn’t indicate mismanagement of funds. Conservative investors may prefer companies with lower D/E ratios, especially if they pay dividends.

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

It’s not just about numbers; it’s about understanding the story behind those numbers. It is crucial to consider the industry norms and the company’s financial strategy when assessing whether or not a D/E ratio is good. Additionally, the ratio should be analyzed with other financial metrics and qualitative factors to get a comprehensive view of the company’s financial health. The D/E ratio is a powerful indicator of a company’s financial stability and risk profile. It reflects the relative proportions of debt and equity a company uses to finance its assets and operations.

What are the Uses of Debt to Equity Ratio?

The ratio can be distorted by retained earnings or losses, intangible assets, and pension plan adjustments, so further research is usually needed to understand to what extent a company relies on debt. The main limitation of debt to equity ratio is that it is difficult to compare across industries. Different normal leverage ranges are maintained by various industries in accordance with their asset requirements and business models. The debt-to-equity ratio has been utilized as a financial metric since the early 20th century to gauge a company’s leverage and solvency. The debt-to-equity ratio is also known as the risk ratio, and it measures the degree to which a company finances its operations through debt versus wholly-owned funds.

• Another key limitation is that the debt-to-equity ratio does not account for what the borrowed funds are used for.
• Therefore, lease liabilities are recorded on a company’s balance sheet and classified as current or non-current liabilities.
• They also assess the D/E ratio in the context of short-term leverage ratios, profitability, and growth expectations.
• It’s not just about numbers; it’s about understanding the story behind those numbers.
• The debt-to-equity ratio is most useful when it’s used to compare direct competitors.

Evaluation of a company’s long-term solvency is another application of the debt-to-equity ratio. It serves as an indicator of an organisation’s capacity to endure economic downturns and other adverse circumstances. Financial risk and the likelihood of insolvency are directly proportional to the amount of debt a company possesses, particularly in the event of insufficient cash flow.

Banks, for example, often have high debt-to-equity ratios since borrowing large amounts of money to 6 reasons to donate your car to charity then try to invest at higher returns is standard practice and doesn’t indicate mismanagement of funds. Investors typically examine a company’s balance sheet to understand its capital structure and assess risk. Companies monitor and identify trends in debt-to-equity ratios as part of their internal financial reporting and analysis. Understanding the debt to equity ratio is essential for anyone dealing with finances, whether you’re an investor, a financial analyst, or a business owner. It shines a light on a company’s financial structure, revealing the balance between debt and equity.

Like start-ups, companies in the growth stage rely on debt to fund their operations and leverage growth potential. Although their D/E ratios will likely be high, it doesn’t necessarily indicate that it is an unattractive business to invest in. The risk might be higher than for an established company, but you have to consider why the company is using debt financing and what it is using the funds for.

For comparison of two or more companies, analyst should obtain the ratio of only those companies whose business models are the same and that directly compete with each other within the industry. Strike offers a free trial along with a subscription to help traders and investors make better decisions in the stock market. It is a problematic measure of leverage, because an increase in non-financial liabilities reduces this ratio.4 Nevertheless, it is in common use.

It’s also important to note that interest rate trends over time affect borrowing decisions, as low rates make debt financing more attractive. Some investors also like to compare a company’s D/E ratio to the total D/E of the S&P 500, which was approximately 1.58 in late 2020 (1). However, if that cash flow were to falter, Restoration Hardware may struggle to pay its debt. It’s clear that Restoration Hardware relies on debt to fund its operations to a much greater extent than Ethan Allen, though this is not necessarily a bad thing. Simply put, the higher the D/E ratio, the more a company relies on debt to sustain itself. So, the debt-to-equity ratio of 2.0x indicates that our hypothetical company is financed with $2.00 of debt for each $1.00 of equity.

They do so because they consider this kind of debt to be riskier than short-term debt, which must be repaid in one year or less and is often less expensive than long-term debt. If a D/E ratio becomes negative, a company may have no choice but to file for bankruptcy. If the D/E ratio of a company is negative, it means the liabilities are greater than the assets. These industry-specific factors definitely matter when it comes to assessing D/E.

The remaining long-term debt is used in the numerator of the long-term-debt-to-equity ratio. 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. The 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.