Debt to Equity Ratio is calculated by dividing the shareholder equity of the company to the total debt thereby reflecting the overall leverage of the company and thus its capacity to raise more debt
Debt to Equity Ratio Formula (Table of Contents)
Debt to Equity Ratio Formula
Debt to equity is a formula that is viewed as a long term solvency ratio. It is a comparison between “external finance” and the “internal finance”.
Let’s have a look at the formula –
In the numerator, we will take “total liabilities” of the firm; and in the denominator, we will consider shareholders’ equity. As shareholders’ equity also includes “preferred stock”, we will also consider that.
Example of Debt to Equity Ratio Formula
Let’s take a simple example to illustrate the debt-equity ratio formula.
Youth Company has the following information –
- Current Liabilities – $49,000
- Non-current Liabilities – $111,000
- Common Stocks – 20,000 shares of $25 each
- Preferred Stocks – $140,000
Find out the debt-equity ratio of Youth Company.
In this example, we have all the information. All we need to do is to 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.
The debt equity ratio formula is –
- Debt equity ratio formula = Total liabilities / Total shareholders’ equity = $160,000 / $640,000 = ¼ = 0.25.
- So the debt to equity of Youth Company is 0.25.
In normal situation, a ratio of 2:1 is considered healthy. From generic perspective, Youth Company could use a little more external financing and it will also help them in accessing the benefits of financial leverage.
Explanation of Debt to Equity Ratio Formula
By using the D/E ratio formula the investors get to know how a firm is doing in capital structure; and also how solvent the firm is, as a whole. When an investor decides to invest into a company, she needs to know the approach of a company.
If the total liabilities of the company are higher compared to the shareholders’ equity, the investor would think whether to invest in the company or not; because having too much debt is too risky for a firm in the long run.
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If the total liabilities of the company 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 achieve financial leverage. However, if the company balances both internal and external finance, then maybe the investor would 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. Looks like an over-leveraged situation.
Use of Debt to Equity Ratio Formula
The formula of D/E is the very common ratio in terms of solvency.
If an investor wants to know the solvency of a company, debt to equity would be the first ratio to cross her mind.
By using debt to equity, the investor not only understands the immediate stance of the company; but also can understand the long-term future of the company.
For example, if a company is using too less of external finance; through debt to equity, the investor would be able to understand that the company is trying to become whole-equity firm. And as a result, the firm wouldn’t be able to use the financial leverage in the long run.
You can use the following formula of D/E Ratio Calculator
Debt Equity Ratio in Excel (with excel template)
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.
Here, First We will find out the Total Liabilities and shareholders’ Equity
Now We will calculate the Debt Equity Ratio using the formula of debt to equity ratio
You can download this formula of debt to equity ratio template here – Debt to Equity Ratio Excel Template
Debt to Equity Ratio Formula Video
This has been a guide to Debt to Equity Ratio Formula, practical examples, and a Debt to Equity ratio calculator along with excel templates. You may also have a look at these articles below to learn more about Financial Analysis –
- Explanation of Leverage Ratios Formula
- Non-Current Liabilities Examples
- Ratio in Excel Formula | Examples
- Examples of Solvency Ratio Formula (with Excel Template)
- Examples of Coverage Ratio Formula(with Excel Template)
- Explanation of the Common Stock Formula
- Shareholder’s Equity Formula
- Equity Ratio
- Debt Coverage Ratio Formula
- Asset Turnover Ratio Formula
- Leverage Ratios Formulas
- Debt Ratio Formula