Debt-to-Equity (D/E) Ratio Formula and How to Interpret It (2024)

What Is the Debt-to-Equity (D/E) Ratio?

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. It is a measure of the degree to which a company is financing its operations with debt rather than its own resources. The debt-to-equity ratio is a particular type of gearing ratio.

Formula and Calculation of the D/E Ratio

$\begin{aligned} &\text{Debt/Equity} = \frac{ \text{Total Liabilities} }{ \text{Total Shareholders' Equity} } \\ \end{aligned}$​Debt/Equity=TotalShareholders’EquityTotalLiabilities​​

The information needed to calculate the D/E ratio can be found on a listed company’s balance sheet. Subtracting the value of liabilities on the balance sheet from that of total assets shown there provides the figure for shareholder equity, which is a rearranged version of this balance sheet equation:

$\begin{aligned} &\text{Assets} = \text{Liabilities} + \text{Shareholder Equity} \\ \end{aligned}$​Assets=Liabilities+ShareholderEquity​

These balance sheet categories may include items that would not normally be considered debt or equity in the traditional sense of a loan or an asset. Because the ratio can be distorted by retained earnings or losses, intangible assets, and pension plan adjustments, further research is usually needed to understand to what extent a company relies on debt.

To get a clearer picture and facilitate comparisons, analysts and investors will often modify the D/E ratio. They also assess the D/E ratio in the context of short-term leverage ratios, profitability, and growth expectations.

How to Calculate the D/E Ratio in Excel

Business owners use a variety of software to track D/E ratios and other financial metrics. Microsoft Excel provides a balance sheet template that automatically calculates financial ratios such as the D/E ratio and the debt ratio.

Or you could enter the values for total liabilities and shareholders’ equity in adjacent spreadsheet cells, say B2 and B3, then add the formula “=B2/B3” in cell B4 to obtain the D/E ratio.

What Does the D/E Ratio Tell You?

The D/E ratio measures how much debt a company has taken on relative to the value of its assets net of liabilities. Debt must be repaid or refinanced, imposes interest expense that typically can’t be deferred, and could impair or destroy the value of equity in the event of a default. As a result, a high D/E ratio is often associated with high investment risk; it means that a company relies primarily on debt financing.

Debt-financed growth may serve to increase earnings, and if the incremental profit increase exceeds the related rise in debt service costs, then shareholders should expect to benefit. However, if the additional cost of debt financing outweighs the additional income that it generates, then the share price may drop. The cost of debt and a company’s ability to service it can vary with market conditions. As a result, borrowing that seemed prudent at first can prove unprofitable later under different circ*mstances.

Changes in long-term debt and assets tend to affect the D/E ratio the most because the numbers involved tend to be larger than for short-term debt and short-term assets. If investors want to evaluate a company’s short-term leverage and its ability to meet debt obligations that must be paid over a year or less, they can use other ratios.

For example, the cash ratio evaluates a company’s near-term liquidity:

$\begin{aligned} &\text{Cash Ratio} = \frac{ \text{Cash} + \text{Marketable Securities} }{ \text{Short-Term Liabilities } } \\ \end{aligned}$​CashRatio=Short-TermLiabilitiesCash+MarketableSecurities​​

So does the current ratio:

$\begin{aligned} &\text{Current Ratio} = \frac{ \text{Short-Term Assets} }{ \text{Short-Term Liabilities } } \\ \end{aligned}$​CurrentRatio=Short-TermLiabilitiesShort-TermAssets​​

Example of the D/E Ratio

Let’s consider an example from Apple Inc. (AAPL). We can see below that for Q1 2024, ending Dec. 30, 2023, Apple had total liabilities of $279 billion and total shareholders’ equity of $74 billion.

Using the above formula, the D/E ratio for Apple can be calculated as:

Debt-to-equity = $279 Billion / $74 Billion = 3.77

The resultmeans that Applehad$3.77of debt for every dollar of equity. But on its own, the ratio doesn’t give investors the complete picture. It’s important to compare the ratio with that of other similar companies.

Modifying the D/E Ratio

Not all debt is equally risky. The long-term D/E ratio focuses on riskier long-term debt by using its value instead of that of total liabilities in the numerator of the standard formula:

Long-term D/E ratio = Long-term debt ÷ Shareholder equity

Short-term debt also increases a company’s leverage, of course, but because these liabilities must be paid in a year or less, they aren’t as risky. For example, imagine a company with $1 million in short-term payables (wages, accounts payable, notes, etc.) and $500,000 in long-term debt, compared with a company with $500,000 in short-term payables and $1 million in long-term debt.

If both companies have $1.5 million in shareholder equity, then they both have a D/E ratio of 1. On the surface, the risk from leverage is identical, but in reality, the second company is riskier.

As a rule, short-term debt tends to be cheaper than long-term debt and is less sensitive to shifts in interest rates, meaning that the second company’s interest expense and cost of capital are likely higher. If interest rates are higher when the long-term debt comes due and needs to be refinanced, then interest expense will rise.

Finally, if we assume that the company will not default over the next year, then debt due sooner shouldn’t be a concern. In contrast, a company’s ability to service long-term debt will depend on its long-term business prospects, which are less certain.

The D/E Ratio for Personal Finances

The D/E ratio can apply to personal financial statements as well, serving as a personal D/E ratio. Here, equity refers to the difference between the total value of an individual’s assets and their aggregate debt, or liabilities. The formula for the personal D/E ratio is slightly different:

$\begin{aligned} &\text{Debt/Equity} = \frac{ \text{Total Personal Liabilities} }{ \text{Personal Assets} - \text{Liabilities} } \\ \end{aligned}$​Debt/Equity=PersonalAssets−LiabilitiesTotalPersonalLiabilities​​

The personal D/E ratio is often used when an individual or a small business is applying for a loan. Lenders use the D/E figure to assess a loan applicant’s ability to continue making loan payments in the event of a temporary loss of income.

For example, a prospective mortgage borrower is more likely to be able to continue making payments during a period of extended unemployment if they have more assets than debt. This is also true for an individual applying for a small business loan or a line of credit.

If the business owner has a good personal D/E ratio, it is more likely that they can continue making loan payments until their debt-financed investment starts paying off.

D/E Ratio vs. Gearing Ratio

Gearing ratios constitute a broad category of financial ratios, of which the D/E ratio is the best known. “Gearing” is a term for financial leverage.

Gearing ratios focus more heavily on the concept of leverage than other ratios used in accounting or investment analysis. The underlying principle generally assumes that some leverage is good, but that too much places an organization at risk.

Limitations of the D/E Ratio

When using the D/E ratio, it is very important to consider the industry in which the company operates. Because different industries have different capital needs and growth rates, a D/E ratio value that’s common in one industry might be a red flag in another.

Utility stocks often have especially high D/E ratios. As a highly regulated industry making large investments typically at a stable rate of return and generating a steady income stream, utilities borrow heavily and relatively cheaply. High leverage ratios in slow-growth industries with stable income represent an efficient use of capital. Companies in the consumer staples sector tend to have high D/E ratios for similar reasons.

Analysts are not always consistent about what is defined as debt. For example, preferred stock is sometimes considered equity, since preferred dividend payments are not legal obligations, and preferred shares rank below all debt (but above common stock) in the priority of their claim on corporate assets. On the other hand, the typically steady preferred dividend, par value, and liquidation rights make preferred shares look more like debt.

Including preferred stock in total debt will increase the D/E ratio and make a company look riskier. Including preferred stock in the equity portion of the D/E ratio will increase the denominator and lower the ratio. This is a particularly thorny issue in analyzing industries notably reliant on preferred stock financing, such as real estate investment trusts (REITs).

The Bottom Line

The debt-to-equity (D/E) ratio can help investors identify highly leveraged companies that may pose risks during business downturns. Investors can compare a company’s D/E ratio with the average for its industry and those of competitors to gain a sense of a company’s reliance on debt. However, not all high D/Eratios signal poor business prospects.

In fact, debt canenable the company to grow and generate additional income. But if a company has grown increasingly reliant on debt or inordinately so for its industry, potential investors will want to investigate further.