What debt-to-equity tells you
The debt-to-equity ratio compares the two ways a business finances its assets, using figures from the same balance sheet. Total liabilities are everything the business owes, current and long-term: loans and bonds, but also amounts owed to suppliers, taxes due and other obligations. Shareholders’ equity is what is left for the owners once liabilities are subtracted from assets.
A result of 1.50 means the business owes 1.50 for every 1.00 of shareholders’ equity. A result below 1.00 means equity is larger than liabilities.
Total liabilities or interest-bearing debt
Sources do not agree on what counts as debt. The main version of this calculator uses total liabilities, as accounting textbooks commonly do. The calculator also offers an interest-bearing debt only mode, which counts loans, bonds and similar borrowings and leaves out supplier balances and other liabilities that carry no interest.
The interest-bearing version gives the same or a lower figure, because it counts fewer liabilities. The two answer slightly different questions: total liabilities shows every claim that ranks ahead of shareholders, while interest-bearing debt shows the borrowing that creates interest and repayment obligations. Some data sources also use the market value of the shares instead of balance sheet equity, which can give a very different result. State which version you use, and compare only figures built the same way.
Reading a high or low result
What is normal varies widely by industry. Businesses that own a lot of long-lived assets often finance part of them with debt, so they tend to show higher ratios.
- A higher ratio means creditors finance more of the business. Borrowing can raise returns to shareholders when the money earns more than it costs, but it also brings fixed obligations that can become hard to meet if profits fall.
- A lower ratio means owners finance more of the business, with less pressure from fixed obligations. It may also mean the business is not using borrowing that could fund growth.
Compare the ratio with the same business in earlier periods, or with similar businesses that use the same definition.
What the ratio does not show
- It does not show whether the business can afford its debt. The interest coverage ratio and the debt service coverage ratio compare earnings with the cost of that debt.
- It ignores the terms of the debt: interest rates, due dates and any security given.
- It is a snapshot of one date, and equity is a book value. After large losses or payouts, equity can be small enough to make the ratio very large. When equity is negative, liabilities exceed assets and the calculator does not give a result.
Common mistakes
- Comparing a total-liabilities figure with an interest-bearing debt figure, or a book-value ratio with a market-value one.
- Leaving short-term borrowings or the current portion of long-term debt out of interest-bearing debt.
- Taking liabilities and equity from different dates.
- Reading a falling ratio as less borrowing when it came from higher equity, for example after a new share issue.
Related measures
The debt-to-assets ratio divides the same liabilities by total assets, so it gives the share of assets financed by creditors rather than a multiple of equity. Debt-to-equity vs debt-to-assets shows how the two relate. Because borrowing can lift return on equity, it is worth reading ROE alongside this ratio.