What is the Debt to Equity Ratio?

The total liabilities are higher than the shareholders’ equity. The investor would think about whether to invest in the company or not; because having too much debt is too risky for a firm in the long run.

If the company’s total liabilities are too low compared to the shareholders’ equity, the investor would also think twice about investing in the company; because then, the company’s capital structure is not conducive enough to achieveFinancial Leverage Ratio measures the impact of debt on the Company’s overall profitability. Moreover, high & low ratio implies high & low fixed business investment cost, respectively. read more financial leverageFinancial LeverageFinancial Leverage Ratio measures the impact of debt on the Company’s overall profitability. Moreover, high & low ratio implies high & low fixed business investment cost, respectively. read more. However, if the company balances both internal and external financeExternal FinanceAn external source of finance is the one where the finance comes from outside the organization and is generally bifurcated into different categories where first is long-term, being shares, debentures, grants, bank loans; second is short term, being leasing, hire purchase; and the short-term, including bank overdraft, debt factoring.read more, the investor might feel that the company is ideal for investment.

Pepsi Debt to Equity was at around 0.50x in 2009-1010. However, it started rising rapidly and is at 2.792x currently. It looks like an over-leveraged situation.

Debt to Equity Ratio Formula

Equity debt is a formula viewed as a long-term solvency ratio. It compares “external finance” and “internal finance.”

Let’s have a look at the formula –

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In the numerator, we will take the “total liabilities” of the firm; and in the denominator, we will consider shareholders’ equity. As shareholders’ equity EquityShareholder’s equity is the residual interest of the shareholders in the company and is calculated as the difference between Assets and Liabilities. The Shareholders’ Equity Statement on the balance sheet details the change in the value of shareholder’s equity from the beginning to the end of an accounting period.read more also includes “preferred stockPreferred StockA preferred share is a share that enjoys priority in receiving dividends compared to common stock. The dividend rate can be fixed or floating depending upon the terms of the issue. Also, preferred stockholders generally do not enjoy voting rights. However, their claims are discharged before the shares of common stockholders at the time of liquidation.read more,” we will also consider that.

Example

Let’s take a simple example to illustrate the debt-equity ratio formula.

Youth Company has the following information –

  • Current Liabilities – $49,000Non-current Liabilities – $111,000Common Stocks – 20,000 shares of $25 eachPreferred Stocks – $140,000

Find out the debt-equity ratio of the Youth Company.

In this example, we have all the information. All we need to do is find out the total liabilities and the total shareholders’ equity.

  • Total liabilities = (Current liabilities + Non-current liabilities) = ($49,000 + $111,000) = $160,000.Total shareholders’ equity = (Common stocks + Preferred stocks) = [(20,000 * $25) + $140,000] = [$500,000 + $140,000] = $640,000.Debt equity ratio = Total liabilities / Total shareholders’ equity = $160,000 / $640,000 = ¼ = 0.25.So the debt to equity of Youth Company is 0.25.

In a normal situation, a ratio of 2:1 is considered healthy. From a generic perspective, Youth Company could use a little more external financing, and it will also help them access the benefits of financial leverage.

Uses

The formula of D/E is the very common ratio in terms of solvency.

If an investor wants to know a company’s solvency, equity debt would be the first ratio to cross her mind.

For example, if a company is using too little external finance, through debt to equity, the investor would be able to understand that the company is trying to become a whole-equity firm. And as a result, the firm wouldn’t be able to use the financial leverage in the long run.

Calculator

You can use the following formula of the D/E Ratio Calculator

Calculate Debt Equity Ratio in Excel

Let us now do the same example above in Excel.

This is very simple. You need to provide the two inputs of total liabilities and the total shareholders’ equity.

You can easily calculate the ratio in the template provided.

First, We will find out the Total Liabilities and shareholders’ Equity.

Now We will calculate the Debt Equity Ratio using the debt to equity ratio formula.

You can download this template here – Debt to Equity Ratio Excel Template.

Debt to Equity Ratio Formula Video

This has guided the Debt to Equity Ratio and its meaning. Here we discuss the formula to calculate the Debt to Equity ratio along with practical examples, its uses, and interpretation and excel templates. You may also have a look at these articles below to learn more about Financial Analysis –

  • Calculate Debt to GDP RatioCalculate Debt To GDP RatioThe debt to GDP ratio is a metric to compare a country’s debt to its GDP and measures its capability to repay its debt. A country with a high ratio would not have difficulty repaying its debt but will not seek debt due to higher chances of defaulting.read moreExamples of Reserve Ratio FormulaExamples Of Reserve Ratio FormulaReserve Ratio is portion of total deposits that commercial banks are obligated to maintain with the central bank in the form of cash reserve. It is calculated by dividing the cash reserve maintained with the central bank by the bank deposits.read moreTypes of Debt ReliefTypes Of Debt ReliefDebt relief is defined as the process of complete or partial forgiveness of debt taken on by individuals, corporations, or nations, with the goal of stopping or slowing debt growth and providing relief to the debt taker.read moreNon-Current Liabilities ExamplesNon-Current Liabilities ExamplesThe most common examples of Non-Current Liabilities are debentures, bond payables, deferred tax liabilities etc. Non-Current Liabilities are the payables or obligations of an entity which might not be settled within twelve months of accounting such transactions. read more