The debt-to-equity ratio (D/E) indicates the relative proportion of
shareholder's equity and debt used to finance a company's assets.
LEARNING OBJECTIVE [ edit ]
Identify the different methods of calculating the debt to equity ratio.
KEY POINTS [ edit ]
The debt-to-equity ratio (D/E) is a financial ratio indicating the
relative proportion of shareholders' equity and debt used tofinance a company's assets. Closely
related to leveraging, the ratio is also known as risk, gearing or leverage.
Preferred stocks can be considered part of debt or equity. Attributing preferred shares to one or
the other is partially a subjective decision.
The formula of debt/ equity ratio: D/E = Debt (liabilities) / equity = Debt / (Assets – Debt) =
(Assets – Equity) / Equity.
TERM [ edit ]
leverage
The use of borrowed funds with a contractually determined return to increase the ability of a
business to invest and earn an expected higher return (usually at high risk).
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Debt toEquity
The debt-to-equity ratio(D/E) is a financialratioindicating the
relativeproportion ofshareholders' equity and debt used to finance a company'sassets. Closely
related to leveraging, the ratio is also known asrisk, gearing or leverage. The two components
are often taken from the firm's balance sheet or statement of financial position. However, the
ratio may also be calculated using market
valuesfor both if the company's debt and
equity are publicly traded, or using a
combination of book value for debt and
market value for equity financially. ""
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Leverage Ratios of Investment Banks
Each of the five largest investment banks took on greater risk leading up to the subprime crisis. This is
summarized by their leverage ratio, which is the ratio of total debt to total equity. A higher ratio
indicates more risk.
Preferred stocks can be considered part of debt or equity. Attributing preferred shares to one
or the other is partially a subjective decision, but will also take into account the specific
features of the preferred shares. When used to calculate a company's financial leverage, the
debt usually includes only the long term debt (LTD). Quoted ratios can even exclude the
current portion of the LTD.
Financial analysts and stock market quotes will generally not include other types of liabilities,
such as accounts payable, although some will make adjustments to include or exclude certain
items from the formal financial statements. Adjustments are sometimes also made, for
example, to exclude intangibleassets, and this will affect the formal equity; debt to equity
(dequity) will therefore also be affected.
The formula of debt/equity ratio: D/E = Debt (liabilities) / equity. Sometimes only interestbearing long-term debt is used instead of total liabilities in the calculation.
A similar ratio is the ratio of debt-to-capital (D/C), where capital is the sum of debt and
equity:D/C = total liabilities / total capital = debt / (debt + equity)
The relationship between D/E and D/C is: D/C = D/(D+E) = D/E / (1 + D/E)
The debt-to-total assets (D/A) is defined asD/A = total liabilities / total assets = debt / (debt
+ equity + non-financial liabilities)
On a balance sheet, the formal definition is that debt (liabilities) plus equity equals assets, or
any equivalent reformulation. Both the formulas below are therefore identical: A = D + EE =
A – D or D = A – E
Debt to equity can also be reformulated in terms of assets or debt: D/E = D /(A – D) = (A –
E) / E