- A debt-to-equity ratio measures a company's financial leverage by comparing total liabilities to its shareholder equity.
- A higher debt-to-equity ratio is often associated with risk, while lower ratios are considered safer, but much is contextual.
- Debt-to-equity ratio varies by industry; financial services and telecommunications typically have higher ratios.
A company's financial health can be evaluated using liquidity ratios such as the debt-to-equity (D/E) ratio, which compares total liabilities to total shareholder equity. A D/E ratio determines how much debt vs. equity a company uses to finance its operations.
When you're analyzing the D/E ratio of a company, it's vital to compare the ratios of other companies within the same industry so you have a better idea of how they're performing.
Here's how a debt-to-equity ratio works and how to analyze company risk using this financial leverage ratio.
What is debt-to-equity ratio?
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 is being used to finance the company vs. the amount of equity owned by shareholders.
Investors typically look at a company's balance sheet to understand the capital structure of a business and assess the risk. Trends in debt-to-equity ratios are monitored and identified by companies as part of their internal financial reporting and analysis.
"Interpreting debt-to-equity ratios is a bit of art mixed with a dash of science," says Robert R. Johnson, PhD, CFA, the founder of Economic Index Associates and professor of finance at Creighton University. " The higher the debt-to-equity ratio is, the greater proportion of a company's finances comes from debt."
In some cases, investors may prefer a higher D/E ratio when leverage is used to finance its growth, as a company can generate more earnings than it would have without debt financing. This is beneficial to investors if leverage generates more income than the cost of the debt. However, share values may fall when the debt's cost exceeds earnings, and a high D/E ratio might correspond with issues like cash flow crunches, due to high debt payments.
Conservative investors may prefer companies with lower D/E ratios, especially if they pay dividends. However, a lower D/E ratio isn't automatically a positive sign — relying on equity to finance operations can be more expensive than debt financing.
How to calculate debt-to-equity ratio (D/E formula)
The debt-to-equity calculation is fairly straightforward: Divide a company's total liabilities by shareholders' equity to calculate the debt-to-equity ratio.
Here's what the formula for calculating the debt-to-equity ratio looks like:
While the D/E ratio formula only has a few steps, it's important to know what each part means. Total liabilities are combined obligations that a company owes other parties, including both short-term ones like accounts payable and long-term ones like certain loans.
Shareholders' equity (aka stockholders' equity) is the owners' residual claims on a company's assets after settling obligations. It also represents a firm's total assets minus liabilities. In other words, this is what shareholders own after accounting for any debts.
How to calculate debt-to-equity ratio in Excel
Using a balance sheet template in Excel is an easy way to calculate a company's debt-to-equity ratio automatically. To calculate the D/E ratio, enter the value for total liabilities and shareholders' equity in adjacent cells, such as A2 and A3, then insert the formula "=A2/A3" (or whatever the corresponding numbers are) in another cell.
What is a good debt-to-equity ratio?
D/E ratios vary by industry and can be misleading if used alone to assess a company's financial health. For this reason, using the D/E ratio, alongside other ratios and financial information, is key to getting the full picture of a firm's leverage.
"A good debt-to-equity ratio really depends on the business in question, both in regards to its own financial strategy and the industry it operates within," says Shaun Heng, director of product strategy at MoonPay.
That said, there are general guidelines to consider.
"Ratios over 2.0 are generally considered risky, whereas a ratio of 1.0 is considered safe," says Heng.
However, that's not foolproof when determining a company's financial health. Some industries, like the banking and financial services sector, have relatively high D/E ratios, and that doesn't mean these companies are in financial distress.
"Some industries are more stable, though, and can comfortably handle more debt than others can," says Johnson. "Industries that require large investment in equipment and those with stable cash flow 一 like electric utilities 一 tend to handle higher debt-to-equity ratios than those with less investment required, like software firms."
A D/E ratio close to zero can also be a negative sign as it indicates that the business isn't taking advantage of the potential growth it can gain from borrowing. Therefore, a "good" debt-to-equity ratio is generally about balance and relative to peers.
Note: Lenders sometimes use a personal debt ratio to determine if an individual or small business can afford to take out a loan or a line of credit. A personal D/E ratio is calculated by dividing total personal liabilities by personal net worth. Or lenders might look at ratios like debt to income. Potential borrowers with good debt ratios are generally more likely to make consistent debt repayments.
Debt-to-equity ratio example
Let's look at a real-life example of one of the leading companies by market cap, Apple, to find out its D/E ratio. Looking at the balance sheet for the 2024 fiscal year, Apple had total liabilities of about $308 billion and total shareholders' equity of around $57 billion.
Using the debt-to-equity formula, the D/E ratio of Apple is calculated by dividing $308 billion by $57 billion. The result is over 5.4, meaning that Apple used more than $5.40 of debt for every dollar of equity. While Apple has a relatively high D/E ratio often associated with risk, it doesn't mean it is experiencing financial distress. Some industries and certain companies have higher D/E ratios than others in positive ways, such as if they've been able to find a formula for borrowing money in a way that potentially yields long-term value. In Apple's case, for example, the company has borrowed money for purposes like share buybacks during periods of low interest rates, which some investors think is a net positive, though it still depends on your perspective.
How to analyze company risk using the D/E ratio
While a D/E ratio isn't a perfect proxy for risk, it can be one of several indicators. Here's how D/E can be viewed in this regard:
Debt-to-equity ratio in decision-making
Since a high debt-equity ratio is often associated with increased risk, many investors prefer businesses with relatively low D/E ratios (somewhere in the range of 1-1.5).
A low D/E ratio indicates a decreased probability of bankruptcy or related issues if the economy takes a hit, potentially making that company more attractive to investors. However, a high D/E ratio isn't necessarily always bad, as it sometimes corresponds with an efficient use of capital. Or, a high D/E may be standard for the industry. Banks, for example, often have high debt-to-equity ratios since borrowing large amounts of money to then try to invest at higher returns is standard practice and doesn't indicate mismanagement of funds.
Investors will also sometimes be discouraged by too low of a D/E ratio (e.g., <1). A ratio close to zero can be a sign that a company isn't taking advantage of the leverage and possible tax advantages that debt capital can provide, and perhaps competitors are better able to fund growth.
So, a D/E ratio on its own doesn't necessarily mean all that much. It can provide a first clue, but you have to dig into the numbers and compare peers.
Debt-to-equity ratio in different economic contexts
Economic factors such as economic downturns and interest rates affect a company's optimal debt-to-income ratio by industry.
Although it will increase their D/E ratios, companies are more likely to take on debt when interest rates are low to capitalize on growth potential and finance operations. Conversely, companies are less likely to take on new debt when interest rates are high, as it's harder for that borrowing to yield a positive return.
Another consideration is that businesses often experience decreased revenue during recessions, making it harder to fulfill debt obligations and potentially raising the D/E ratio. Those that already have high D/E ratios are the most vulnerable to economic downturns, because declining profits then make it harder to pay back debt, which can lead to further borrowing or issues like bankruptcy.
Still, there are different motivations to increase a D/E ratio. Like start-ups, companies in the growth stage rely on debt to fund their operations and leverage growth potential. Although their D/E ratios will likely be high, it doesn't necessarily indicate that it is an unattractive business to invest in. The risk might be higher than for an established company, but you have to consider why the company is using debt financing and what it is using the funds for.
Debt to equity ratio in decision making
Since a high debt-to-equity ratio is associated with increased risk, investors typically prefer businesses with low to moderate D/E ratios (1-2). Overleveraged companies might not appeal to potential investors due to the increased probability of bankruptcy.
A low D/E ratio indicates a decreased probability of bankruptcy if the economy takes a hit, making it more attractive to investors. However, a high D/E ratio isn't necessarily always bad, as it sometimes indicates an efficient use of capital. Or, a high D/E may be standard for the industry. Banks, for example, often have high debt-to-equity ratios since borrowing large amounts of money is standard practice and doesn't indicate mismanagement of funds.
Investors will also be discouraged by too low of a D/E ratio (<1). A ratio close to zero can be a sign that a company isn't taking advantage of the leverage of debt capital and the potential for accelerated growth and tax advantages.
Debt-to-equity ratio in different economic contexts
Economic factors such as economic downturns and interest rates affect a company's optimal debt-to-income ratio by industry.
Although it will increase their D/E ratios, companies are more likely to take on debt when interest rates are low to capitalize on growth potential and fund finance operations. Companies are less likely to take on new debt when high interest rates.
Businesses often experience decreased revenue during recessions, making it harder to fulfill debt obligations and thus raising the D/E ratio. Those that already have high D/E ratios are the most vulnerable to economic downturns. Even if the business isn't taking on new debt, declining profits can continue to raise the D/E ratio. On the bright side, this may prevent companies from over-leveraging.
Like start-ups, companies in the growth stage rely on debt to fund their operations and leverage growth potential. Although their D/E ratios will be high, it doesn't necessarily indicate that it is a risky business to invest in.
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Debt-to-equity ratio frequently asked questions
What is considered a good debt-to-equity ratio?
A good debt-to-equity ratio is often a relatively low D/E ratio of around 1-1.5. However, what is actually a "good" debt-to-equity ratio varies by industry, as some industries (like finance) borrow large amounts of money as standard practice. On the other hand, businesses with D/E ratios too close to zero are sometimes seen as not leveraging growth potential, and much is context-dependent.
Can a company have a negative debt-to-equity ratio?
A company with a negative net worth can have a negative debt-to-equity ratio. A negative D/E ratio means that the total value of the company's assets is less than the total amount of debt and other liabilities. This could indicate financial instability and the potential for bankruptcy. However, some companies like startups with a negative D/E ratio aren't always cause for concern, as it could take time to build equity that improves the D/E ratio.
How does debt-to-equity ratio differ from debt-to-asset ratio?
Debt-to-equity and debt-to-asset ratios are both used to measure a company's risk profile. The debt-to-asset ratio measures how much of a company's assets are financed by debt, while the debt-to-equity ratio accounts for shareholder capital. A company might have a high debt-to-asset ratio, for example, if it has few assets, its debt-to-equity ratio may be healthier if it has accumulated significant investor capital that can be used to pay back debt and grow assets over time. With debt-to-equity ratios and debt-to-assets ratios, lower is generally favored, but the ideal can vary by industry.
Is a high debt-to-equity ratio always bad?
A high debt-to-equity ratio isn't bad but is often a sign of higher risk. Some industries, such as finance, utilities, and telecommunications, normally have higher leverage due to the high capital investment required.
How frequently should a company analyze its debt-to-equity ratio?
How frequently a company should analyze its debt-to-equity ratio varies from company to company, but generally, publicly traded companies in the U.S. report the information behind D/E ratios — total liabilities and shareholders' equity — in their quarterly and annual financial statements. However, they may monitor D/E ratios more frequently, such as monthly, to identify potential trends or issues.
