Debt to Equity Ratio (Meaning, Formula)

What is Debt to Equity Ratio?

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

By using the D/E ratio 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 in 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.

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. It looks like an over-leveraged situation.

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 the “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

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

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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.
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 in accessing 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 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 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 D/E Ratio Calculator

Total Liabilities
Shareholders' Equity
Debt to Equity Ratio Formula

Debt to Equity Ratio Formula =

Total Liabilities
	=
Shareholders' Equity

0
	=	0
0

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.

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 template here – Debt to Equity Ratio Excel Template