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Debt-to-Equity Ratio
Overview
The debt-to-equity ratio is a leverage ratio that calculates the proportion of total debt and liabilities
versus total shareholders’ equity. The ratio compares whether a company’s capital structure utilizes
more debt or equity financing.
The ratio looks at total debt which consists of short-term debt, long-term debt, and other fixed
payment obligations (such as capital leases).
Formula
Interpretation
If the total debt of a business is worth $50 million and the total equity is worth $120 million, as per
the above formula, debt-to-equity would be 0.42. In other words, the firm has 42 cents in debt for
every dollar of equity.
A higher debt-equity ratio indicates a levered firm – a firm that is financed with debt. Leverage
has benefits such as tax deductions on interest expenses but also the risks associated with
these expenses. Thus, leverage is preferable for companies with stable cash flows, but not for
companies in decline. The appropriate debt-to-equity ratio varies by industry.
Corporate Finance Institute
Financial Ratios
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