The
debt-to-equity ratio (D/E) is a
financial ratioIn finance, a financial ratio or accounting ratio is a ratio of two selected numerical values taken from an enterprise's financial statements. There are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization...
indicating the relative proportion of equity and
debtDebt is that which is owed; usually referencing assets owed, but the term can also cover moral obligations and other interactions not requiring money. In the case of assets, debt is a means of using future purchasing power in the present before a summation has been earned...
used to finance a company's assets. This ratio is also known as Risk, Gearing or Leverage. It is equal to total
debtDebt is that which is owed; usually referencing assets owed, but the term can also cover moral obligations and other interactions not requiring money. In the case of assets, debt is a means of using future purchasing power in the present before a summation has been earned...
divided by shareholders' equity. The two components are often taken from the firm's
balance sheetIn financial accounting, a balance sheet or statement of financial position is a summary of a person's or organization's balances. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a snapshot of a...
or statement of financial position (so-called book value), but the ratio may also be calculated using market values for both, if the company's debt and equity are publicly traded, or using a combination of book value for debt and market value for equity.
Preferred shares can be considered part of debt or equity.
The
debt-to-equity ratio (D/E) is a
financial ratioIn finance, a financial ratio or accounting ratio is a ratio of two selected numerical values taken from an enterprise's financial statements. There are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization...
indicating the relative proportion of equity and
debtDebt is that which is owed; usually referencing assets owed, but the term can also cover moral obligations and other interactions not requiring money. In the case of assets, debt is a means of using future purchasing power in the present before a summation has been earned...
used to finance a company's assets. This ratio is also known as Risk, Gearing or Leverage. It is equal to total
debtDebt is that which is owed; usually referencing assets owed, but the term can also cover moral obligations and other interactions not requiring money. In the case of assets, debt is a means of using future purchasing power in the present before a summation has been earned...
divided by shareholders' equity. The two components are often taken from the firm's
balance sheetIn financial accounting, a balance sheet or statement of financial position is a summary of a person's or organization's balances. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a snapshot of a...
or statement of financial position (so-called book value), but the ratio may also be calculated using market values for both, if the company's debt and equity are publicly traded, or using a combination of book value for debt and market value for equity.
Usage
Preferred shares can be considered part of debt or equity. Attributing preferred shares to one or the other is partially a subjective decision but will also take into account the specific features of the preferred shares.
When used to calculate a company's financial leverage, the debt usually includes only the Long Term Debt (LTD). Quoted ratios can even exclude the current portion of the LTD. The composition of equity and debt and its influence on the value of the firm is much debated and also described in the
Modigliani-Miller theoremThe Modigliani-Miller theorem forms the basis for modern thinking on capital structure. The basic theorem states that, under a certain market price process , in the absence of taxes, bankruptcy costs, and asymmetric information, and in an efficient market, the value of a firm is unaffected by how...
.
Financial analysts and stock market quotes will generally not include other types of liabilities, such as
accounts payableAccounts payable is a file or account that contains money that a person or company owes to suppliers, but has not paid yet . When you receive an invoice you add it to the file, and then you remove it when you pay...
, although some will make adjustments to include or exclude certain items from the formal financial statements. Adjustments are sometimes also made to, for example, exclude intangible assets, and this will affect the formal equity; debt to equity (dequity) will therefore also be affected.
Financial
economistAn economist is an expert in the social science of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy...
s and academic papers will usually refer to all liabilities as debt, and the statement that equity plus liabilities equals assets is therefore an
accounting identityIn finance and economics, an accounting identity is an equality that must be true regardless of the value of its variables, or a statement that by definition must be true. The term is also used in economics to refer to equalities that are by definition or construction true, such as the balance of...
(it is, by definition, true). Other definitions of debt to equity may not respect this accounting identity, and should be carefully compared.
Formula
- D/E = Debt(liabilities)/equity
(Sometimes only interest-bearing long-term debt is used instead of total liabilities in the calculation)
A similar ratio is debt-to-total assets (D/A), also known as debt-to-value:
- D/A = total liabilities / total assets = debt / (debt + equity)
The relationships between D/E and D/A are:
- D/A = D/E / (1 + D/E)
- D/E = D/A / (1 – D/A)
In the financial industry (particularly banking), a similar concept is equity to total assets (or equity to risk-weighted assets), otherwise known as capital adequacy:
- Capital Adequacy = E / A
Since D + E = A (by the
accounting equation is the foundation for the double-entry bookkeeping system.It shows how assets were financed: either by borrowing money from someone or by paying your own money .-How it works:...
), D/A + E/A = 1, so E/A = 1 - D/A. For instance, if a company has 10% capital adequacy, they have 90% debt-to-assets.
Background
On a
balance sheetIn financial accounting, a balance sheet or statement of financial position is a summary of a person's or organization's balances. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a snapshot of a...
, the formal definition is that debt (liabilities) plus equity equals assets, or any equivalent reformulation. Both the formulas below are therefore identical:
- A = D + E
- E = A – D or D = A – E.
Debt to equity can also be reformulated in terms of assets or debt:
- D/E = D /(A – D) = (A – E) / E.
Example
General Electric Co. (
http://finance.yahoo.com/q/bs?s=GE&annual)
- Debt / equity: 4.304 (total debt / stockholder equity) (340/79). Note: This is often presented in percentage form, for instance 430.4.
- Other equity / shareholder equity: 7.177 (568,303,000/79,180,000)
- Equity ratio
The equity ratio is a financial ratio indicating the relative proportion of equity to all used to finance a company's assets. The two components are often taken from the firm's balance sheet or statement of financial position , but the ratio may also be calculated using market values for both, if...
: 12% (shareholder equity / all equity) (79,180,000/647,483,000)