Vareto Finance Glossary
Total Debt-to-Equity Ratio
Definition
One finance rule that applies to every company is to spend as per the availability of funds and borrow as per the payback affordability. A company’s debt-to-equity ratio is a metric that checks the extent to which it can afford to repay debt. The debt-to-equity ratio is calculated by dividing total debt by shareholders’ equity. If the D/E ratio is higher, it means potential difficulty in covering liabilities as the company’s debt is significantly high relative to its assets.
Example
Suppose, a company's financials are as below:Liabilities – $100,000Total shareholders’ equity = $200,000.Therefore, its Debt equity ratio will be = Total liabilities / Total shareholders’ equity = 100,000 / 200,000 = 0.5This means the company has $0.5 of debt for every dollar of equity. Although this signals lower risk for investors and stakeholders, it is important to compare a company's DE ratio with its peers in the same industry.
Why it matters
Since the debt-to-equity ratio considers owned capital and borrowed capital, it provides a true insight into the company’s financial health. DE ratio reflects whether the company’s dependency is more on borrowed capital (debt) or whether it is using owned capital.If a company has more borrowings that exceed the owned capital, it is not considered a healthy financial situation. In such cases, investors may check if the company is capable of covering its debt obligations.
See Vareto in action
Give your finance team the tools needed to launch your company into the future.