Debt-to-Equity D E Ratio: Meaning and Formula
To get a sense of what this means, the figure needs to be placed in context by comparing it to competing companies. Determining whether a company’s ratio is good or bad means considering other factors in conjunction with the ratio. Pete Rathburn is a copy editor and fact-checker with expertise in economics and personal finance and over twenty years of experience in the classroom. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications.
11 Financial’s website is limited to the dissemination of general information pertaining to its advisory services, together with access to additional investment-related information, publications, and links. Quick assets are those most liquid current assets that can quickly be converted into cash. These assets include cash and cash equivalents, marketable securities, and net accounts receivable. On the other hand, when a company sells equity, it gives up a portion of how is computer software classified as an asset its ownership stake in the business.
- Tesla had total liabilities of $30,548,000 and total shareholders’ equity of $30,189,000.
- In other words, the debt-to-equity ratio shows how much debt, relative to stockholders’ equity, is used to finance the company’s assets.
- A company with a higher ratio than its industry average, therefore, may have difficulty securing additional funding from either source.
- Businesses often experience decreased revenue during recessions, making it harder to fulfill debt obligations and thus raising the D/E ratio.
- They can also issue equity to raise capital and reduce their debt obligations.
The following D/E ratio calculation is for Restoration Hardware (RH) and is based on its 10-K filing for the financial year ending on January 29, 2022. Of note, there is no “ideal” D/E ratio, though investors generally like it to be below about 2. Someone on our team will connect you with a financial professional in our network holding the correct designation and expertise. At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content.
The Importance of This Metric
A business that ignores debt financing entirely may be neglecting important growth opportunities. The benefit of debt capital is that it allows businesses to leverage a small amount of money into a much larger sum and repay it over time. This allows businesses to fund expansion projects more quickly than might otherwise be possible, theoretically increasing profits at an accelerated rate. However, what is actually a «good» debt-to-equity ratio varies by industry, as some industries (like the finance industry) borrow large amounts of money as standard practice.
Other Related Ratios for Specific Uses
Debt-to-equity and debt-to-asset ratios are used to measure a company’s risk profile. The debt-to-equity ratio measures how much debt and equity a company uses to finance its operations. The debt-to-asset ratio measures how much of a company’s assets are financed by debt. With debt-to-equity ratios and debt-to-assets ratios, lower is generally favored, but the ideal can vary by industry. The debt-to-equity ratio (aka the debt-equity ratio) is a metric used to evaluate a company’s financial leverage by comparing total debt to total shareholder’s equity. In other words, it measures how much debt and equity a company uses to finance its operations.
Why Companies Use Debt (Debt Financing)
Interest payments on debt are tax-deductible, which means that the company can reduce its taxable income by deducting the interest expense from its operating income. The debt capital is given by the lender, who only receives the repayment of capital plus interest. Whereas, equity financing would entail the issuance of new shares to raise capital which dilutes the ownership stake of existing shareholders.
Let’s look at a real-life example of one of the leading tech companies by market cap, Apple, to find out its D/E ratio. Looking at the balance sheet for the 2023 fiscal year, Apple had total liabilities of $290 billion and total shareholders’ equity of $62 billion. If a company has a negative D/E ratio, this means that it has negative shareholder equity. In most cases, this would be considered a sign of high risk and an incentive to seek bankruptcy protection. On the other hand, the typically steady preferred dividend, par value, and liquidation rights make preferred shares look more like debt.
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As a result, your total monthly debt payments and your DTI ratio would decrease, but your total debt outstanding would remain unchanged. The D/E ratio can be classified as a leverage ratio (or gearing ratio) that shows the relative amount of debt a company has. As such, it is also a type of solvency ratio, which estimates how well a arun mago cpa pllc dba mago tax services company can service its long-term debts and other obligations. This is in contrast to a liquidity ratio, which considers the ability to meet short-term obligations.
In most cases, liabilities are classified as short-term, long-term, and other liabilities. For growing companies, the D/E ratio indicates how much of the company’s growth is fueled by debt, which investors can then use as a risk measurement tool. In fact, debt can enable the company to grow and generate additional income. But if a company has grown increasingly reliant on debt or inordinately so for its industry, potential investors will want to investigate further. When using the D/E ratio, it is very important to consider the industry in which the company operates. Because different industries have different capital needs and growth rates, a D/E ratio value that’s common in one industry might be a red flag in another.
The preference for low DTI ratios makes sense since lenders want to be sure a borrower isn’t overextended, meaning they have too many debt payments relative to their income. The DTI ratio is one of the metrics that lenders, including mortgage lenders, use to measure an individual’s ability to manage monthly payments and repay debts. The lower the DTI ratio, the better the chance that the borrower will be approved or considered for the credit application. This ratio compares a company’s total liabilities to its shareholder equity. It is widely considered one of the most important corporate valuation metrics because it highlights a company’s dependence on borrowed funds and its ability to meet those financial obligations.
