Debt-to-Equity Ratio

This ratio is one of the most widely used measures of financial leverage. It compares the funding provided by lenders with the funding provided by shareholders.

For example, a company with total debt of 400,000 and shareholders' equity of 800,000 has a debt-to-equity ratio of 0.5. For every unit of equity, it has 0.5 units of debt. A ratio of 2.0 would mean twice as much debt as equity.

Definitions vary. Some analysts include only interest-bearing debt, such as loans and bonds, while others include all liabilities. Some also include lease liabilities. Consistency matters when comparing companies.

A higher ratio means more leverage, which can boost returns to shareholders when the business is doing well but increases risk when it struggles, because interest and repayments must be made regardless of profits.

What counts as a reasonable ratio depends on the industry. Capital-intensive businesses with stable cash flows, such as utilities, often have higher ratios, while businesses with volatile earnings tend to keep them lower. Lenders frequently set maximum debt-to-equity levels in loan agreements.