Debt to Equity Ratio

The debt to equity ratio is a comparison of how much of the financing of assets comes from creditors with the amount of financing that comes from owners in the form of equity.

In the debt to equity ratio, “total liabilities” includes all liabilities and “total equity” consists of all stockholders’ equity including preferred equity.

A debt to equity ratio of 2.00, or 2:1, for example, means that the company’s total debt is twice its total equity, or its debt financing consists of $2.00 of debt for every $1.00 of equity.

The debt to equity ratio can serve as a screening device for the analyst when looking at capital structure ratios. If this ratio is extremely low (for instance, 0.1:1), then there is no need to calculate other capital structure ratios because there is no real concern with this part of the company’s financial situation.

The analyst’s time could be better spent looking at other aspects of the company’s operations. However, if the debt to equity ratio is in the neighborhood of 2:1 or higher, it would be important to do some extended analysis that focuses on other ratios such as profitability, as well as the company’s future prospects.