Debt Equity Ratio

How much leverage does a company have?

What is the Debt Equity ratio?

The Debt-Equity ratio (also called the “debt to equity ratio”, “risk ratio” or “gearing”), is a leverage ratio that calculates the weight of total debts and financial liabilities to the sum of shareholder’s equity. Unlike the debt ratio which uses total assets as a denominator, the debt to equity ratio uses total equity. This ratio highlights whether creditors or investors have the most amount of money infused in the company.

Debt equity ratio formula

​Debt to Equity Ratio = Total Debt / Total Equity

Debt to equity in practice

If, as per the balance sheet, the total liabilities of a business are 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 entail 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 succeeding, but not preferable when a company is in decline. Conversely, a lower ratio indicates a firm closer to full-equity. These firms are better than leveraged firms in times when business is rough.

What are Total Liabilities?

Total liabilities are total debts, or a sum of the short-term and long-term obligations of a business that are incurred while under normal operating cycles. Creating a debt schedule helps split out liabilities by specific pieces.

Current or Short-term liabilities include accounts payable, notes payable (maturity within a year), accrued expenses, unearned revenues, and dividends payable.

Long-term liabilities include notes payable (maturity more than a year), bonds payable, and credit lines offered by financial institutions.