Decoding Debt-to-Equity Ratio: Key Metrics for Businesses | Mailchimp (2024)

FAQs

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

The debt-to-equity (D/E) ratio is used to evaluate a company's financial leverage and is calculated by dividing a company's total liabilities by its shareholder equity. The D/E ratio is an important metric in corporate finance.

There are two main components in the ratio: total debt and shareholders equity. Shareholder's equity is already mentioned in the balance sheet as a separate sub-head so that does not need to be calculated per say. What needs to be calculated is 'total debt'.

Generally speaking, a debt-to-equity ratio of 1.5 or less is considered good. A high debt-to-equity ratio indicates that a company funds its operations and growth primarily with debt, indicating a higher risk profile because they have more debt to repay.

Debt-to-equity ratio interpretation

Your ratio tells you how much debt you have per $1.00 of equity. A ratio of 0.5 means that you have $0.50 of debt for every $1.00 in equity. A ratio above 1.0 indicates more debt than equity. So, a ratio of 1.5 means you have $1.50 of debt for every $1.00 in equity.

The formula for calculating the debt-to-equity ratio is to take a company's total liabilities and divide them by its total shareholders' equity. A good debt-to-equity ratio is generally below 2.0 for most companies and industries.

Category: Finance KPIs. The debt to equity ratio is another important liquidity ratio. Fundamentally, it compares a firm's total debt in relation to its total equity. The debt to equity ratio displays the percentage of company financing that is derived from creditors and investors.

What is a bad debt-to-equity ratio? When the ratio is more around 5, 6 or 7, that's a much higher level of debt, and the bank will pay attention to that. “It doesn't mean the company has a problem, but you have to look at why their debt load is so high,” says Lemieux.

Companies usually have a choice as to whether to seek debt or equity financing. The choice often depends upon which source of funding is most easily accessible for the company, its cash flow, and how important maintaining control of the company is to its principal owners.

One of the most effective ways to do this is to increase revenue. Then, as your company's equity increases, you can use the funds to pay off debts or purchase new assets, thereby keeping your debt-to-equity ratio stable. Effective inventory management is also important.

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.

What debt-to-equity ratio is too high? ›

Generally, a good debt-to-equity ratio is anything lower than 1.0. A ratio of 2.0 or higher is usually considered risky. If a debt-to-equity ratio is negative, it means that the company has more liabilities than assets—this company would be considered extremely risky.

Lenders prefer bad debt to sales ratios under 0.4 or 40%. However, most companies prefer to have much lower numbers than this. Unless you have no bad debt, there is room to improve.

The debt-to-equity ratio is a measure of a firm's Financial leverage.

The equity ratio indicates the proportion of a company's assets that are financed by equity. A higher equity ratio suggests a more financially stable company, as it relies less on debt financing.

The debt ratio is a financial metric that indicates the proportion of a company's resources that are financed by debt. It is calculated by dividing the company's total liabilities by its total assets. This ratio provides insight into the company's financial leverage and potential financial risk.

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.

The debt-to-equity ratio measures your company's total debt relative to the amount originally invested by the owners and the earnings that have been retained over time.

Generally, a good debt-to-equity ratio is anything lower than 1.0. A ratio of 2.0 or higher is usually considered risky. If a debt-to-equity ratio is negative, it means that the company has more liabilities than assets—this company would be considered extremely risky.