Debt-to-Equity Ratio

In one sentence: The debt-to-equity ratio shows how much a business is funded by borrowing compared with money from its owners: a higher number means more debt.

$\text{D/E} = \frac{\text{Total liabilities}}{\text{Shareholders' equity}}$

Read it out loud: “D over E equals total liabilities divided by shareholders' equity. Total liabilities are everything the business owes. Shareholders' equity is the owners' share, which is what the business owns minus what it owes. The result is a plain number, with no unit.”

Before you start

The ideas and signs this page uses, explained from zero. For powers of ten, Greek letters and other notation in general, see Math basics.

Assets, liabilities and equity: An asset is something a company owns, such as cash, buildings or machines. A liability is something it owes to someone else. Equity is what remains for the owners: assets minus liabilities. The three are linked by one rule, assets equal liabilities plus equity.
Shareholders and shares: A share is one small piece of ownership in a company. A shareholder is someone who owns shares. Their combined stake in the business is called shareholders’ equity.
Creditors, interest and interest-bearing debt: A creditor is anyone the business owes money to. Interest is the fee a borrower pays a lender for using the money, usually a percentage of the amount borrowed each year. Interest-bearing debt is debt that carries such a fee, such as a bank loan or a bond.
Ratio and the fraction bar: A ratio compares two amounts by division. The fraction bar in $\frac{a}{b}$ means divide $a$ by $b$ . A result of 0.8 means four fifths of the bottom amount, because 0.8 is 4 out of 5.
The balance sheet: The balance sheet is a list of assets, liabilities and equity on a single date. It is a snapshot, not a film: it shows where the business stood at one moment.

What each symbol means

Symbol	Meaning
$\text{D/E}$	The debt-to-equity ratio itself, the result. It has no unit, because dollars divided by dollars cancel. A value of 0.8 means 0.8 dollars owed to others for each dollar the owners hold.
$\text{Total liabilities}$	Everything the business owes to anyone: suppliers, banks, bondholders and others. Measured in dollars.
$\text{Shareholders' equity}$	The owners’ share of the business, which is everything it owns minus everything it owes. Shareholders are the people who own shares in the company. Measured in dollars.

The formula piece by piece

$\text{Total liabilities}$: Start with the top of the fraction. This is the total of all money the company owes to outsiders, whether it was borrowed or is owed for goods and services.
$\text{Shareholders' equity}$: This is the bottom of the fraction. It is the owners’ share, mainly the money the owners put in plus the profits the company has kept. It is what is left after all debts are paid from everything owned.
$\frac{\text{Total liabilities}}{\text{Shareholders' equity}}$: Divide the debts by the owners’ share. The result shows how many dollars of outside claims stand behind each dollar of owners’ money.
$\text{D/E} = \frac{\text{Total liabilities}}{\text{Shareholders' equity}}$: The whole formula in one sentence: the debt-to-equity ratio equals total liabilities divided by shareholders’ equity.
$\text{D/E} = \frac{\text{Interest-bearing debt}}{\text{Shareholders' equity}}$: Another standard form that counts only borrowed money that carries interest, such as bank loans and bonds. It gives a smaller number than the total-liabilities version, so always check which form is being used.

What the formula is doing, and why

A business pays for what it owns in two ways. It can borrow money, which it must repay, or it can use money from its owners, which belongs to them. The debt-to-equity ratio compares those two sources. It asks: for every dollar the owners have put in and left in the business, how many dollars does the business owe to others?

Why divide? Dividing one total by the other gives a fair comparison that does not depend on the size of the company. A large firm and a small firm can be compared by their ratios, even though one has millions of dollars more in total. A ratio of 1 means debts and owners’ money are equal. A ratio above 1 means the business owes more than its owners hold.

Why total liabilities on top? Many analysts use total liabilities, which includes everything owed, such as unpaid supplier bills and wages owed to staff. Others use only interest-bearing debt, which is money borrowed from banks and bond buyers that carries interest. That version is smaller, so its ratio is lower. Both are used, so check which one a source uses before comparing two numbers.

What the ratio tells you. Debt makes a business riskier, because interest and repayments must be paid even in a bad year. Owners’ money does not have to be repaid on a schedule. A high ratio means more of the business depends on lenders, which can work well in good times and hurt in bad ones. A low ratio means the owners carry more of the risk themselves.

Where equity comes from. Shareholders’ equity is what remains after subtracting total liabilities from total assets, the same relation that the accounting equation describes. So the two sides of this ratio always come from one balance sheet, and that is why the ratio can be read as a split of how the company is paid for.

An everyday picture

Think of buying a house that costs 500000 dollars with a mortgage. If you paid 100000 dollars from your own savings and borrowed 400000 dollars from a bank, the bank’s share compared with your share is 400000 divided by 100000, which is 4. A business works the same way: the lenders’ claim is set against the owners’ money. Both kinds of money pay for the same thing, and the ratio shows how much of the purchase rests on borrowing.

Worked example: How much does Cedar Furniture Co owe compared with its owners’ money?

Cedar Furniture Co is a made-up company that builds wooden chairs and tables. Its balance sheet at year end shows 250000 dollars of bank loans, 150000 dollars owed to timber suppliers and other creditors, and 500000 dollars of shareholders’ equity. We want the debt-to-equity ratio. Then we will repeat the calculation using only the bank loans, which is the version some analysts prefer.

Add up total liabilities. Total liabilities include everything the company owes, so we add the bank loans and the supplier debts: $250000 + 150000 = 400000\ \text{dollars}$ . Both kinds of money are owed to outside parties, so both count.
Read the shareholders’ equity. The balance sheet gives this figure directly as 500000 dollars. It is the owners’ share, the amount left after all debts are subtracted from everything the company owns, so we use it as it stands.
Divide liabilities by equity. Using the formula, $\frac{400000\ \text{dollars}}{500000\ \text{dollars}} = 0.8$ . The dollar units cancel, so the ratio is a plain number.
Read the answer in words. A value of 0.8 means the company owes 0.8 dollars to outsiders for every 1 dollar its owners have put in and left in the business. Because the value is below 1, the owners’ money is the larger share of the funding.
Repeat the calculation with bank loans only. Some analysts count only interest-bearing debt, which is the money borrowed from banks. Dividing the 250000 dollars of bank loans by the 500000 dollars of equity gives $\frac{250000}{500000} = 0.5$ . The supplier debts are left out because they do not carry interest, so this version is lower.
Check the balance sheet. Total assets must equal total liabilities plus equity, so the company owns $400000 + 500000 = 900000\ \text{dollars}$ of assets. The owners and the lenders together pay for everything the company owns, which confirms the figures fit together.

Answer: Cedar Furniture Co has a debt-to-equity ratio of 0.8, which means outsiders hold a claim of 0.8 dollars for each dollar the owners hold. Counting only bank loans, the ratio is 0.5. Always check which version a source uses before comparing two companies.

The numbers in this example are recomputed by script every time the site is built.

Common mistakes

Putting equity on top. Flipping the fraction makes a company with more debt than equity look as if it has less debt.
Comparing ratios that were calculated with different definitions. One source may use only interest-bearing debt, and another may use all liabilities.
Forgetting that equity can be small or negative. When liabilities are bigger than assets, equity turns negative, and the ratio stops being a useful comparison.
Judging a ratio without its industry. Businesses that need heavy equipment, such as airlines or utilities, often carry more debt than a software firm, so compare like with like.
Using book equity as if it were the market value of the shares. The balance sheet records equity at accounting values, which can differ a lot from what the shares sell for.

Where you will meet it

Bank and bond analysis, where lenders check how much a company already owes before lending more.
Equity research, where analysts compare how much of each competitor’s funding comes from debt.
Credit ratings, where rating agencies consider leverage as one of several measures of a borrower’s strength.
Planning a leveraged buyout, where investors judge how much borrowed money a deal can safely carry.

Questions people ask

Is a debt-to-equity ratio of 1 good or bad?

Neither by itself. A ratio of 1 means debts and owners’ money are equal. Whether that is comfortable depends on how steady the business’s income is and on what its industry normally carries.

Why does the ratio rise when a company loses money?

Equity is what the owners have left after debts. A loss reduces the profits the company has kept over the years, which is part of equity. Equity falls while debt stays the same, so the ratio rises.

Where do I find these numbers?

On the balance sheet, which is published in a public company’s annual report and is often on its investor relations page. Use the same balance date for both total liabilities and equity, so the two numbers describe the same moment.

Accounting Equation: The accounting equation says everything a business owns equals what it owes to others plus what belongs to its owners.
Current Ratio: The current ratio tells you whether a business has enough short-term assets to cover its short-term debts, by dividing one total by the other.
Weighted Average Cost of Capital (WACC): WACC is the average yearly price a company pays for all the money it uses, mixing the owners’ price and the lenders’ price by how much of each it has.