The debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of shareholders' equity and

debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The d ...

used to finance a company's assets. Closely related to leveraging, the ratio is also known as risk, gearing or leverage. The two components are often taken from the firm's

balance sheet In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a busine ...

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 A public company is a company whose ownership is organized via shares of stock which are intended to be freely traded on a stock exchange or in over-the-counter markets. A public (publicly traded) company can be listed on a stock exchange ( l ...

, or using a combination of book value for debt and market value for equity financially.

Usage

Preferred stock Preferred stock (also called preferred shares, preference shares, or simply preferreds) is a component of share capital that may have any combination of features not possessed by common stock, including properties of both an equity and a debt ins ...

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 theorem The Modigliani–Miller theorem (of Franco Modigliani, Merton Miller) is an influential element of economic theory; it forms the basis for modern thinking on capital structure. The basic theorem states that in the absence of taxes, bankruptcy ...

. Financial

economist An economist is a professional and practitioner in the social science discipline of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy. Within this field there are ...

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 identity (it is, by definition, true). Other definitions of debt to equity may not respect this accounting identity, and should be carefully compared. Generally speaking, a high ratio may indicate that the company is much resourced with (outside) borrowing as compared to funding from shareholders.

Formula

In a general sense, the ratio is simply debt divided by equity. However, what is classified as debt can differ depending on the interpretation used. Thus, the ratio can take on a number of forms including: *Debt / Equity *Long-term Debt / Equity *Total Liabilities / Equity In a basic sense, Total Debt / Equity is a measure of all of a company's future obligations on the balance sheet relative to equity. However, the ratio can be more discerning as to what is actually a borrowing, as opposed to other types of obligations that might exist on the balance sheet under the liabilities section. For example, often only the liabilities accounts that are actually labelled as "debt" on the balance sheet are used in the numerator, instead of the broader category of "total liabilities". In other words, actual borrowings like bank loans and interest-bearing debt securities are used, as opposed to the broadly inclusive category of total liabilities which, in addition to debt-labelled accounts, can include accrual accounts like unearned revenue. Another popular iteration of the ratio is the long-term-debt-to-equity ratio which uses only long-term debt in the numerator instead of total debt or total liabilities. Total debt includes both long-term debt and short-term debt which is made up of actual short-term debt that has actual short-term maturities and also the portion of long-term debt that has become short-term in the current period because it is now nearing maturity. This second classification of short-term debt is carved out of long-term debt and is reclassified as a current liability called ''current portion of long-term debt'' (or a similar name). The remaining long-term debt is used in the numerator of the long-term-debt-to-equity ratio. A similar ratio is debt-to-capital (D/C), where capital is the sum of debt and equity: :D/C = = The relationship between D/E and D/C is: :D/C = = The debt-to-total assets (D/A) is defined as :D/A = = It is a problematic measure of leverage, because an increase in non-financial liabilities reduces this ratio. Nevertheless, it is in common use. 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.

Background

On 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 = = .

Example

General Electric Co.

*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: 12% (shareholder equity / all equity) (79,180,000/647,483,000)

References

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