In situations of declining revenues from the company, a rise in this means declining profits. However, it is important to note that financial leverage can increase a company’s profits by allowing it to invest in growth opportunities with borrowed money. So, a company with low debt-to-equity ratio may be missing out on the potential to increase profits through financial leverage. The debt-to-equity ratio (D/E) is a financial ratio that indicates the relative amount of a company’s equity and debt used to finance its assets. The D/E ratio can be classified as a leverage ratio (or gearing ratio) that shows the relative amount of debt a company has.

• Debt-to-equity ratio is just one piece of the puzzle when it comes to evaluating stocks.
• At its simplest, the debt-to-equity ratio is a quick way to assess a company’s total liabilities vs. total shareholder equity, to gauge the company’s reliance on debt.
• Generally, a D/E ratio of more than 1.0 suggests that a company has more debt than assets, while a D/E ratio of less than 1.0 means that a company has more assets than debt.
• All of our content is based on objective analysis, and the opinions are our own.
• Tesla had total liabilities of $30,548,000 and total shareholders’ equity of $30,189,000.

Related Terms

However, since they have high cash flows, paying off debt happens quickly and does not pose a huge risk to the company. The debt-to-equity ratio is the most important financial ratio and is used as a standard for judging a company’s financial strength. When examining the health of a company, it is critical to pay attention to the debt-to-equity ratio. If the ratio is rising, the company is being financed by creditors rather than from its own financial sources, which can be a dangerous trend. Lenders and investors usually prefer low debt-to-equity ratios because their interests are better protected in the event of a business decline.

Financial Leverage

Therefore, it is essential to align the ratio with the industry averages and the company’s financial strategy. The D/E ratio illustrates the proportion between debt and equity in a given company. In other words, the debt-to-equity ratio shows how much debt, relative to stockholders’ equity, is used to finance the company’s assets. This debt to equity calculator helps you to calculate the debt-to-equity ratio, otherwise known as the D/E ratio. This metric weighs the overall debt against the stockholders’ equity and indicates the level of risk in financing your company. Capital-intensive sectors, such as utilities and manufacturing, often have higher ratios due to the need for significant upfront investment.

What Does It Mean for a Debt-to-Equity Ratio to Be Negative?

For example, a company may not borrow any funds to support business operations, not because it doesn’t need to but because it doesn’t have enough capital to repay it promptly. This may mean that the company doesn’t have the potential for much growth. Many companies borrow money to maintain business operations — making it a typical practice for many businesses. For companies with steady and consistent cash flow, repaying debt happens rapidly. Also, because they repay debt quickly, these businesses will likely have solid credit, which allows them to borrow inexpensively from lenders.

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. 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, balanced scorecard which are less certain. 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. All these ratios are complementary, and their use and interpretation should consider the context of the company and the industry it operates in.

Get in Touch With a Financial Advisor

Investors may check it quarterly in line with financial reporting, while business owners might track it more regularly. For startups, the ratio may not be as informative because they often operate at a loss initially. In this guide, we’ll explain everything you need to know about the D/E ratio to help you make better financial decisions. If you want to express it as a percentage, you must multiply the result by 100%. Overall, the D/E ratio provides insights highly useful to investors, but it’s important to look at the full picture when considering investment opportunities. These industry-specific factors definitely matter when it comes to assessing D/E.

For shareholders, it means a decreased probability of bankruptcy in the event of an economic downturn. A company with a higher ratio than its industry average, therefore, may have difficulty securing additional funding from either source. Understanding the debt to equity ratio is essential for anyone dealing with finances, whether you’re an investor, a financial analyst, or a business owner. It shines a light on a company’s financial structure, revealing the balance between debt and equity. It’s not just about numbers; it’s about understanding the story behind those numbers.

A higher D/E ratio means that the company has been aggressive in its growth and is using more debt financing than equity financing. Over time, the cost of debt financing is usually lower than the cost of equity financing. This is because when a company takes out a loan, it only has to pay back the principal plus interest. The debt-to-equity ratio (D/E) is calculated by dividing the total debt balance by the total equity balance.

A lower ratio often expresses conservatism, and high, or a higher, one may indicate high risks or high dependence on debt. As this ratio helps an investor formulate sound investment decisions according to the stability and growth possibilities regarding the company, one tends to be more conservative as concerns high risks. The debt to asset ratio, in combination with other financial ratios, can be analyzed to understand and appreciate the overall financial strategy and stability of the company. Debt-to-equity is a gearing ratio comparing a company’s liabilities to its shareholder equity.