Explanation: The debt-to-equity (D/E) ratio is a financial leverage ratio that compares a company’s total liabilities to its shareholder equity. This ratio is used to evaluate a company’s financial leverage and is a measure of the degree to which a company is financing its operations through debt versus wholly-owned funds. A higher ratio indicates more leverage and greater financial risk.
Example: If a company has total liabilities of $500,000 and shareholder equity of $1,000,000, its D/E ratio is 0.5 ($500,000 / $1,000,000). This means the company uses 50 cents of debt for every dollar of equity.
Reference Link: For more information on the debt-to-equity ratio, visit Investopedia’s Debt-to-Equity Ratio.
FAQs:
- What is a good debt-to-equity ratio?
- It varies by industry, but generally, a D/E ratio below 1.0 is considered good, indicating lower risk.
- How does the debt-to-equity ratio impact a company’s risk?
- A higher D/E ratio indicates higher financial risk as the company relies more on debt financing, which can be risky if earnings are volatile.
- Can the debt-to-equity ratio be negative?
- Yes, if a company’s liabilities exceed its equity, the ratio can be negative, indicating insolvency.
- How does the debt-to-equity ratio affect a company’s ability to raise capital?
- Companies with lower D/E ratios may find it easier to raise capital as they are seen as less risky by investors and lenders.
- What is the difference between debt-to-equity ratio and equity multiplier?
- The equity multiplier is a measure of financial leverage that indicates how much of a company’s assets are financed by equity, while the D/E ratio compares total liabilities to shareholder equity.