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.
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