A debit to equity ratio is a financial and liquidity ratio that calculates the weight of total debt and financial liabilities against the total shareholders’ equity. The debt-to-equity ratio shows the proportions that a debt takes (from the equity of a company) that the company is using in order to finance its assets. It is a measurement of the ability of shareholders equity to fulfil obligations to the creditors in case the business starts declining.
The formula for calculating debt to equity ratio is Total Liabilities divided by Total shareholders equity. The booth of these numbers can be found on the balance sheet of the company financial statements. Debt to Equity Ratio = Total Debt / Shareholders’ Equity
In simple terms, debt to equity is a measure of how much of the company equity is owned by investors and how much by debtors. For example if company has debt to equity ratio of 0.45, that means that for every dollar or equity in the company 45 cents are in leverage. Or in other worths the company its using 45% of their financing from leverage and 55% from shareholders.
The debt to equity ratio is a simple formula to show how capital has been raised to run and grow a business. A higher debt-equity ratio indicates a leveraged company , which is might be quite preferable for a stable and predictable business with significant cashflow generation, but not preferable when a company is in decline or has very unpredictable cash flow. Usually higher D/E ratio tend to suggest a company or stock with higher risk to shareholders. Lower ratio indicates a business with less leverage and closer to being fully equity financed. A lower debt to equity ratio usually implies a more financially stable business. The appropriate debt to equity ratio varies by industry. This is because different types of businesses require different levels of debt and capital to operate and scale.