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Debt to equity ratio definition

Description

Debt to equity ratio (D/E) indicates company’s capital structure, showing the proportion between equity and debt. In other words, it shows how much is the borrowed money worth in comparison to one own dollar. Data needed to calculate this ratio is collected from balance sheet.

The debt to equity ratio is one of the leverage ratios. This ratio is important to shareholders as well as to creditors (suppliers, banks, and etc.), because it shows the proportion between their money invested to the company.

Norms and limitations

It is an industry - dependent ratio. Ratio above 2 might be considered good for such industries as shipbuilding. However, in restaurant business the ratio that equals 2 is a bad sign.

A high D/E ratio indicates that a company carries out an aggressive financial policy. It must also be mentioned that a higher level of borrowed funds means greater interest expense. Also D/E value might be affected by the company’s size. For large companies, a higher value is more acceptable than for smaller ones.

Formula

Debt (total debt, total liabilities) is calculated by adding together the long term debt with the short term debt. These two measures can be easily located on the balance sheet.

Equity (Shareholders’ equity) shows the equity stake, currently held on company’s balance sheet. In other words, it means total assets minus total debt.