Formula
D/E Ratio = Total Liabilities ÷ Shareholders' Equity
The Short Version
D/E measures how much a company relies on borrowed money (debt) versus shareholder money (equity) to fund its operations. It's a key gauge of financial risk — more debt means more fixed obligations (interest payments) that must be paid regardless of how business is going.
Explain It Like I'm 10
Imagine buying a $100 skateboard. You pay $60 of your own saved allowance and borrow $40 from your parents that you have to pay back. Your 'debt-to-equity' here is $40 borrowed ÷ $60 of your own money ≈ 0.67. The more you borrow compared to what's actually yours, the riskier your situation gets if something goes wrong — you still owe that $40 no matter what happens to the skateboard.
Step-by-Step Example
- 1 Total liabilities (everything the company owes): $150,000,000.
- 2 Shareholders' equity (the owners' actual stake): $75,000,000.
- 3 Divide: $150,000,000 ÷ $75,000,000 = 2.0 D/E ratio.
- 4 This means the company has $2 of debt for every $1 that actually belongs to its owners.
- 5 That's on the higher end — it works fine if the company earns steady, reliable cash flow to cover the debt payments, but it becomes dangerous quickly if business slows down, since the debt payments don't slow down with it.
Quick Recap
- ✓ A D/E above 2.0 (i.e., $2 of debt for every $1 of equity) is generally considered higher risk, though 'normal' varies a lot by industry.
- ✓ Capital-intensive industries (utilities, telecom, airlines) typically run higher D/E than software or services companies.