Debt-to-Equity Ratio

The debt-to-equity ratio allows a company to measure its solvency and ability to meet obligations

The debt-to-equity ratio helps a business measure its ability to dissolve and meet obligations in both the short and long term. It shows how much of its financing is coming from borrowing (debt) and from its shareholders (equity).

The more debt that a company has, the more profit it must generate, for the company must be able to pay back the debt and its associated interest. This ratio varies drastically from industry to industry, so it is important to compare it to the industry when evaluating. If the ratio is 1:1 (one to one), half of the assets in the company are funded by debt, and the other half is shareholders' equity. If it is greater than one, there is more debt than shareholder equity, and if it is less than one, there is more shareholder equity than debt.

Total liabilities in the equation above refers to the total debt of the company while total equity is equal to the total shareholders' equity.

Examples

Company 1 just got a business loan for $100,000 and has retained earnings of $20,000. Company 2 just got a $50,000 business loan and has retained earnings of $100,000. Both companies have no other debt or shareholders' equity. Which company has the higher debt-to-equity ratio?

Company 1: 100,000/20,000=5 or 5 to 1

Company 2: 50,000/100,000=0.5 or 0.5 to 1

Company 1 has the higher debt to equity ratio. More of the assets in company one are financed by debt than equity because it is greater than 1. More of the assets in company two are financed by shareholders' equity because the ratio is less than 1.

In 2017, Apple Inc had $241,272 million in total debt, and it had $134,047 million in shareholder equity. Find the debt-to-equity ratio, and interpret it.

241,272/134,047=1.8 or 1.8 to 1

Apple had $1.80 of debt for every dollar of shareholders' equity.

Sources

https://www.investopedia.com/terms/d/debtequityratio.asp

https://www.educba.com/debt-to-equity-ratio-formula/