Debt-to-equity ratio

Definition

The debt-to-equity ratio is a solvency ratio that measures the proportion of a company's debt to its shareholders' equity. It indicates how much debt a company is using to finance its assets relative to the value represented in shareholders’ equity.

5 Must Know Facts For Your Next Test

1. Debt-to-equity ratio is calculated by dividing total liabilities by shareholders' equity.
2. A high debt-to-equity ratio typically indicates higher financial risk due to increased leverage.
3. This ratio helps investors and creditors assess the financial stability and risk level of a company.
4. Industries with stable cash flows, such as utilities, may have higher acceptable debt-to-equity ratios compared to more volatile industries.
5. Debt-to-equity ratios can vary widely between industries; therefore, it's important to compare it with industry benchmarks.

Review Questions

• What does a high debt-to-equity ratio suggest about a company's financial risk?
• How do you calculate the debt-to-equity ratio?
• Why is it important to compare a company's debt-to-equity ratio with industry standards?

Related terms

Liquidity Ratio: A measure of a company’s ability to meet its short-term obligations using its most liquid assets.

Interest Coverage Ratio:

A metric used to determine how easily a company can pay interest on outstanding debt.

Equity Multiplier: A financial leverage ratio that shows the proportion of assets financed by shareholders' equity.