# Debt to equity ratio

Debt to equity ratio (also termed as debt equity ratio) is a long term solvency ratio that indicates the soundness of long-term financial policies of a company. It shows the relation between the portion of assets financed by creditors and the portion of assets financed by stockholders. As the debt to equity ratio expresses the relationship between external equity (liabilities) and internal equity (stockholder’s equity), it is also known as “external-internal equity ratio”.

## Formula:

Debt to equity ratio is calculated by dividing total liabilities by stockholder’s equity.

The numerator consists of the total of current and long term liabilities and the denominator consists of the total stockholders’ equity including preferred stock. Both the elements of the formula are obtained from company’s balance sheet.

A D V E R T I S E M E N T

## Example 1:

ABC company has applied for a loan. The lender of the loan requests you to compute the debt to equity ratio as a part of the long-term solvency test of the company.

The “Liabilities and Stockholders’ Equity” section of the balance sheet of ABC company is given below:

Required: Compute debt to equity ratio of ABC company.

### Solution:

Debt to equity ratio = Total liabilities/Stockholders’ equity
= 7,250/8,500
= 0.85

The debt to equity ratio of ABC company is 0.85 or 0.85 : 1. It means the liabilities are 85% of stockholders equity or we can say that the creditors provide 85 cents for each dollar provided by stockholders to finance the assets.

## Significance and interpretation:

A ratio of 1 (or 1 : 1) means that creditors and stockholders equally contribute to the assets of the business.

A less than 1 ratio indicates that the portion of assets provided by stockholders is greater than the portion of assets provided by creditors and a greater than 1 ratio indicates that the portion of assets provided by creditors is greater than the portion of assets provided by stockholders.

Creditors usually like a low debt to equity ratio because a low ratio (less than 1) is the indication of greater protection to their money. But stockholders like to get benefit from the funds provided by the creditors therefore they would like a high debt to equity ratio.

Debt equity ratio vary from industry to industry. Different norms have been developed for different industries. A ratio that is ideal for one industry may be worrisome for another industry. A ratio of 1 : 1 is normally considered satisfactory for most of the companies.

If debt to equity ratio and one of the other two equation elements is known, we can work out the third element. Consider the example 2 and 3.

## Example 2 – computation of stockholders’ equity when total liabilities and debt to equity ratio are given

The Petersen Trading Company has total liabilities of \$937,500 and a debt to equity ratio of 1.25. Calculate total stockholders’ equity of Petersen Trading Company.

### Solution

Debt to equity ratio = Total liabilities/Total stockholder’s equity
or
Total stockholder’s equity = Total liabilities/Debt to equity ratio
= \$937,500/1.25
= \$750,000

## Example 3 – computation of total liabilities when stockholders’ equity and debt to equity ratio are given

The Steward Corporation’s debt to equity ratio for the last year was 0.75 and stockholders’ equity was \$750,000. What was the total liabilities of the corporation?

### Solution

Debt to equity ratio = Total liabilities/Total stockholder’s equity
or
Total liabilities = Stockholders’ equity × Debt to equity ratio
= \$750,000 × 0.75
= \$562,500

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32 Comments on Debt to equity ratio
1. Jaydip

How To Calculate Gearing Ratio

Total Debt/Net Worth Meaning

1. Gearing ratio. Long term debt/share capital+reserve+longtrmdebt

2. Accounting for Management

(1). A ratio that compares debts and equities of a company or the ability of a company to meet its debt related expenses (interest on borrowed funds etc.) is known as gearing ratio. Examples of gearing ratios are debt to equity ratio, capital gearing ratio, fixed assets to equity ratio and times interest earned ratio.

(2). Debt to net worth ratio (or total debt/net worth)and debt to equity ratio are the same.

3. Sophie

what if my debt to equity ratio is greater than 1, for example it is 40.6 or 4058%?
how do i explain it by comparing it with a debt – equity ratio of 0.7237 or 72.37%?

4. Accounting for Management

Sophie, In your example you want to say 0.406 or 40.58%, not 40.6 or 4058%.

In first situation, creditors contribute \$0.406 for each dollar invested by stockholders whereas in second situation, creditors contribute \$0.7237 for each dollar invested by stockholders.

5. what does it mean as below?
debt equity ratio does not exceed 60:40

6. Accounting For Management

Liabilities: 60
Stockholders’ equity: 40

7. kimberly

excellent explanation

8. Aunya

what if two companies debt to equity ratio are the same?

9. Godwin Akparhuere

What is the relationship of the two variables (i.e. debt and equity) to retained earnings?

10. shankar

hi… lets say the debt to equity ratio for a company is 196.38%.. how do I explain this…

11. zawani md tahir

how about i got the total is 10.88? so it will be 1088% .. how can i explain it pleasee help mee!!!!

12. Mary B.

Hi…i think there is a misunderstanding here. What Accounting For Management last June 14 is saying is the debt to asset ratio and not debt to equity ratio. In debt to asset ratio, total asset is 100% while in debt to equity ratio, Total equity is 100%.

For example:

Debt to asset ratio of 40%. It means that 40% of the total asset is owned by external creditors while the 60% is owned by the company’s stockholders. If the answer is 100%, this means that all resources are financed by the company’s creditors and total equity is equal to “0”. This ratio will not exceed 100%.

Debt to equity ratio of 40%. This depicts that the company’s liabilities is only 40% compared to the company’s stockholders. This indicates that the company is taking little debt and thus has low risk. This ratio can exceed 100%. If the debt to equity ratio is 100%, it means that total liability is equal to total equity, thus, when you compute the debt to asset ratio, the answer will be 50%. However, if the answer for the debt to equity ratio is more than 100%, it means that total liability is higher than the company’s capital or total equity.

Thus, zawani md tahir, when you say that the debt to equity ratio is 10.88 or 1088%, the debt is 10 times of the company’s total equity. It indicates that the company has been heavily taking on debt and thus has high risk.

Hope my answer helps in explaining the difference between debt to asset ratio and debt to equity ratio. Both ratios pertains to the company’s leverage.

1. Eddie

Excellent! Am fine, thank you.

2. Priscilla Asare

I like the explanation. Thanks soo much you have made me my day

13. Accounting For Management

Thank you for your contribution Mary B.

14. Shaq

what does a debt to equity ratio of 0.4 mean.

I am try to work out the asset beta of a company

X plc has gearing ratio (debt :equity ) of 0.4 and the beat of its shares is 1.8.
The rate of corporation tax is 30%.

What is xplc asset beta.
Formula
Ba=Be(Ve/Ve+(Vd(1-.30)

15. nandini

will secured and unsecured loans be added to
owners fund.. ?!?

16. Simbu

What is Leverage? I read some where leverage of less than 10 is good.. is it same as debt equity ratio?

17. divya patil

I want problems on liquid ratio, current ration and depth to equity ratio with detil explanation. Plz i m requstng u send me today itself nly. Plz sir

18. sunil kumar

sir if the company debt equity ratio is -3 what is the interpretation for that

19. Taurus

Can anyone help me in solving this question?

The firms HL and LL are identical except for their leverage ratios and interest rates they pay on debt. Each has \$20 million in assets, earned \$4 million of EBIT, and is in the 40 percent federal-plus-state tax bracket. Firm HL, however, has a debt to equity ratio of 1.2 and pays 10 percent interest on its debt, whereas LL has debt to equity ratio of 0.7 and pays only 8 percent interest on its debt. Calculate the ROE.

20. Taha Sarfraz

Find Total Capital when equity ratio is 5:8 and total assets is 80000.

21. Shameer alam

Is long term provision added while calculating debt equity ratio?

22. S K Gupta

i think equity ratio means debt to equity ratio. If it is so then Capital will be Rs 30000/-

23. Hellow everyone can anybody help me.
i have 2 questions about DEbt Euity Ratio.
a) Why is a high debt-equity ratio of banks considered as favorable?

b) Why banks put limitations on the maximum D/E ratio of companies while sanctioning loans?

24. Why banks put limitations on the maximum D/E ratio of companies while sanctioning loans?

25. selma

how do i interpret a debt -to-equity ratio of 20% and 35% industry average?

26. Please What if Debt to Equity is 8.220 or 822%

27. karen

ok, this is a dumb question Im sure but brain is tired. If the debt ratio is given how do i figure what liabilities and equity is?

28. Kevin

What does -1.2 debt to equity mean?

29. Priscilla Asare