Debt to Equity Ratio (2024)

How much leverage does a company have

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Written byCFI Team

What is the Debt to Equity Ratio?

The Debt to Equity ratio (also called the “debt-equity ratio”, “risk ratio”, or “gearing”), is aleverage ratio that calculates the weight of total debt and financial liabilities against total shareholders’ equity. Unlike the debt-assets ratio which uses total assets as a denominator, the D/E Ratio uses total equity. This ratio highlights how a company’s capital structure is tilted either toward debt or equity financing.

Debt to Equity Ratio Formula

Short formula:

Debt toEquity Ratio in Practice

If, as per the balance sheet, the total debt of a business is worth $50 million and the total equity is worth $120 million, then debt-to-equity is 0.42. This means that for every dollar in equity, the firm has 42 cents in leverage. A ratio of 1 would imply that creditors and investors are on equal footing in the company’s assets.

A higher debt-equity ratio indicates a levered firm, which is quite preferable for a company that is stable with significant cash flow generation, but not preferable when a company is in decline. Conversely, a lower ratio indicates a firm less levered andcloser to beingfully equity financed. The appropriate debt to equity ratio varies by industry.

Learn all about calculating leverage ratios step by step in CFI’sFinancial Analysis Fundamentals Course!

What is Total Debt?

A company’s total debt isthe sum of short-term debt, long-term debt, and other fixed payment obligations (such as capital leases) of a business that are incurred while under normal operating cycles.Creating a debt schedule helps split out liabilities by specific pieces.

Not all current and non-current liabilities are considered debt. Below are some examples of things that are and are not considered debt.

Considered debt:

Drawn line-of-credit
Notes payable (maturity within a year)
Current portion of Long-Term Debt
Notes payable (maturity more than a year)
Bonds payable
Long-Term Debt
Capital lease obligations

Not considered debt:

Accounts payable
Accrued expenses
Deferred revenues
Dividends payable

Benefits of a High D/E Ratio

A high debt-equity ratio can be good because it shows that a firm can easily service its debt obligations (through cash flow) and is using the leverage to increase equity returns.

Drawbacks of a High D/E Ratio

The opposite of the above example applies if a company has a D/E ratio that’s too high. In this case, any losses will be compounded down and the company may not be able to service its debt.

If the debt to equity ratio gets too high, the cost of borrowing will skyrocket, as will the cost of equity, and the company’s WACC will get extremely high, driving down its share price.

Debt to Equity Ratio Calculator

Below is a simple example of an Excel calculator to download and see how the number works on your own.

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Debt Equity Ratio Template

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Video Explanation of the Debt to Equity Ratio

Below is a short video tutorial that explains how leverage impacts a company and how to calculate the debt/equity ratio with an example.

Video: CFI’s Financial Analysis Courses

Additional Resources

Debt/Equity Swap

Free Fundamentals of Credit Course

Analysis of Financial Statements

Financial Modeling Guide

See all commercial lending resources

See all capital markets resources

FAQs

Debt to Equity Ratio? ›

Generally, a good debt-to-equity ratio is anything lower than 1.0. A ratio of 2.0 or higher is usually considered risky.

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What is an acceptable debt-to-equity ratio? ›

The maximum acceptable debt-to-equity ratio for more companies is between 1.5-2 or less. Large companies having a value higher than 2 of the debt-to-equity ratio is acceptable. 3. A debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations.

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How to comment on debt-to-equity ratio? ›

Among similar companies, a higher D/E ratio suggests more risk, while a particularly low one may indicate that a business is not taking advantage of debt financing to expand. Investors will often modify the D/E ratio to consider only long-term debt because it carries more risk than short-term obligations.

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Is 0.5 a good debt-to-equity ratio? ›

The lower value of the debt-to-equity ratio is considered favourable, as it indicates a reduced risk. So, if the ratio of debt to equity is 0.5, that means that the company has half its liabilities because it has equity.

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What does a debt-to-equity ratio of 200% mean? ›

A higher D/E ratio means the company may have a harder time covering its liabilities. For example: $200,000 in debt / $100,000 in shareholders' equity = 2 D/E ratio. A D/E can also be expressed as a percentage. In this example, a D/E of 2 also equals 200%.

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Is a debt-to-equity ratio of 0.75 good? ›

Good debt-to-equity ratio for businesses

Many investors prefer a company's debt-to-equity ratio to stay below 2—that is, they believe it is important for a company's debts to be only double their equity at most. Some investors are more comfortable investing when a company's debt-to-equity ratio doesn't exceed 1 to 1.5.

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Is 3.5 a good debt-to-equity ratio? ›

Although it varies from industry to industry, a debt-to-equity ratio of around 2 or 2.5 is generally considered good.

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Is 0.6 a good debt-to-equity ratio? ›

In general, many investors look for a company to have a debt ratio between 0.3 and 0.6. From a pure risk perspective, debt ratios of 0.4 or lower are considered better, while a debt ratio of 0.6 or higher makes it more difficult to borrow money.

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What does a debt-to-equity ratio of 0.4 mean? ›

Most lenders hesitate to lend to someone with a debt to equity/asset ratio over 40%. Over 40% is considered a bad debt equity ratio for banks. Similarly, a good debt to asset ratio typically falls below 0.4 or 40%. This means that your total debt is less than 40% of your total assets.

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What does a 1.5 debt-to-equity ratio mean? ›

A debt-to-equity ratio of 1.5 would indicate that the company in question has $1.50 of debt for every $1 of equity. To illustrate, suppose the company had assets of $2 million and liabilities of $1.2 million. Since equity is equal to assets minus liabilities, the company's equity would be $800,000.

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What is a fair debt-to-equity ratio? ›

For a fast-growing profitable company, debt to equity ratio of 2 is considered acceptable. For companies that are backed by venture capital and have decided to grow first (without current period PAT profitability), the debt to equity ratio acceptable to lenders like CII is significantly lower.

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What is the Vanguard debt-to-equity ratio? ›

American Vanguard Debt to Equity Ratio: 0.5033 for March 31, 2024.

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Is 1.75 a good debt-to-equity ratio? ›

Key Takeaways

The debt-to-equity ratio is calculated by dividing a corporation's total liabilities by its shareholder equity. The optimal D/E ratio varies by industry, but it should not be above a level of 2.0.

Is a debt-to-equity ratio of 50% good? ›

Is a debt ratio of 50% good? Yes, a D/E ratio of 50% or 0.5 is very good. This means it is a low-debt business and the company's equity is twice as high as its debts.

Is a debt ratio of 75% good? ›

By calculating the ratio between your income and your debts, you get your “debt ratio.” This is something the banks are very interested in. A debt ratio below 30% is excellent. Above 40% is critical. Lenders could deny you a loan.

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Why is a 1.2 debt-to-equity ratio good? ›

With a debt to equity ratio of 1.2, investing is less risky for the lenders because the business is not highly leveraged — meaning it isn't primarily financed with debt.

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