Debt to Equity
Debt to equity ratio (also known as D/E ratio, Debt/Equity) measures how big is company’s debt compared to its book capital (equity). The higher is the debt to equity ratio the higher is the insolvency risk of the company. D/Equity ratio is calculated for some particular day using financial data from balance sheet. Seasonal companies have unstable D/E during seasons because of different working capital need and in such case annual average of debt to equity should be used.
Debt to equity ratio calculation
(1) D/E = Total liabilities / Equity
* Total liabilities and shareholders’ equity of the same date from balance sheet.
** You may multiply the result by 100%.
(2) D/E = Net financial debt / Equity
*** Net financial debt is equal to interest bearing liabilities (including short-term and long-term) less financial assets (mainly cash). All data can be found in company’s balance sheet. (2) Financial debt represents company’s financial leverage better than total liabilities and this type of calculation and is used more by finance professionals.
**** You may multiply the result by 100%.
Debt to equity interpretation
D/E ratio represents company’s capital structure and there is no debt/equity ratio that would meet target capital structure for all the companies at the same time the best. For some stable companies this ratio may reach 0.5-1.0 or it may be even higher if company needs large investments in assets and has stable cash flow. However for other rapidly growing companies in volatile sectors even 0.5 D/E ratio may be dangerous and would mean high financial leverage.
To estimate solvency risk of the company more financial ratios should be calculated and compared to other companies in the same industry group: