What is Debt to Equity Ratio?
The Debt to Equity Ratio measures how your organization is funding its growth and how effectively you are using shareholder investments. A high Debt to Equity Ratio is evidence of an organization that’s fuelling growth by accumulating debt. This is a common practice, as outside investment can greatly increase your ability to generate profits and accelerate business growth. Reaching too far, however, can backfire and leave the company bankrupt. As such, a high Debt to Equity Ratio is often interpreted as a sign of risk.
How to calculate Debt to Equity Ratio
ƒ (Total Liabilities) / (Shareholders Equity)
What is a good Debt to Equity Ratio benchmark?
Most Debt to Equity Ratios are below 1, while capital intensive businesses usually top the list at ratios that may exceed 2.
More about this metric
Although there are variations on what should be considered as part of debt, Total Liabilities should be used, though it often includes only Long Term Debt (LTD), and occasionally even without the current portion of LTD.
It should be noted that Debt to Equity Ratios are difficult to compare across industries, due to varying capital needs or their ability to borrow at different rates, however can be quite effective within an industry to identify companies at risk.
Generally speaking, a lower ratio is considered better and reduces the cash flow burden to repay interest and/or principal. Higher Debt to Equity Ratios, such as 0.6 and higher, may increase the difficulty in borrowing more money. But again, this has much to do with the industry you are in and how lenders are able to manage their risk.
Consider however a company that doesn't have any debt. Especially when lending rates are low, not taking on any debt is a very conservative approach, and may ultimately limit the company's growth. This is why the benchmark for this metric is a range.
Metrics related to Debt to Equity Ratio