Debt-to-Equity Ratio Calculator
What is the Debt-to-Equity Ratio?
The debt-to-equity (D/E) ratio measures how much debt your business carries compared to the amount invested by its owners. In other words, the ratio indicates the amount of liabilities the business has for every dollar of shareholders’ equity.
What is the Ratio Used For?
Analyzing the debt-to-equity ratio allows us to notice some essential aspects of the condition of your business and the operating style.
If the D/E ratio is high, that means the company funds their operations mostly by debt, which is often associated with high levels of risk. However, it also comes with benefits. If the cost of debt continues to be lower than the returns, companies with high D/E ratio can generate more earnings and grow faster than they would without this additional source of funds.
If the D/E ratio is lower, this means investors fund more of the company’s assets than creditors (e.g. bank loans). This is usually preferred by prospective investors as it generally indicates a financially stable and well-performing business.
Determining whether a debt-to-equity ratio is tricky as it heavily depends on the industry. In capital-intensive industries, such as oil and gas, a typical D/E ratio can be as high as 2.0. On the other hand, other sectors would consider 0.7 an extremely high D/E ratio.
Debt-to-Equity Ratio Formula
In order to calculate the debt-to-equity ratio, you will need two pieces of information:
Total Liabilities: Short-term debt, long-term debt, and other financial obligations
Shareholders’ Equity: Book value of the company (sum of the company’s assets – liabilities)
At Flow Capital, we provide alternative debt to high-growth companies. Let’s say two companies apply for growth capital, so we look into their debt-to-equity ratios.
- Total Liabilities: $750M
- Stockholders’ Equity: $350M
- Total Liabilities: $40M
- Stockholders’ Equity: $125M
By using the debt-to-equity formula mentioned above, we get the following results:
- (750/350) * 100% = 214%
- (40/125) * 100% = 32%
What do these results mean?
Company A has a high D/E ratio, which could indicate an aggressive and risky funding style.
On the other hand, Company B has a much lower ratio and is more financially stable. However, it cannot reach the same levels of ROE (return on equity) as company A in the case of success.