This calculator gives estimates for education and planning. It is not investment, tax or legal advice; for decisions about your own situation, talk to a qualified financial professional.
How a company is financed
Every company’s assets are paid for either by debt, money it owes, or by equity, money invested by shareholders and profits kept in the business. The balance between the two, called leverage, affects both risk and return. Debt is usually cheaper than equity and can raise returns to shareholders, but interest must be paid in good times and bad, and too much debt can lead to default.
The ratios
- Debt-to-equity (D/E) = total debt ÷ shareholders’ equity
- Net debt to equity = (debt − cash) ÷ equity
- Total liabilities to equity = all liabilities ÷ equity
- Debt ratio = total liabilities ÷ total assets, with assets = liabilities + equity
- Equity ratio = equity ÷ total assets
- Equity multiplier = total assets ÷ equity, one of the three parts of the DuPont analysis of return on equity
Example
A company has $400,000 of loans, $100,000 of cash, $600,000 of total liabilities and $500,000 of equity:
- D/E: 400,000 ÷ 500,000 = 0.8
- Net debt to equity: 300,000 ÷ 500,000 = 0.6
- Total liabilities to equity: 1.2
- Debt ratio: 600,000 ÷ 1,100,000 = 54.5%
- Equity ratio: 45.5%
- Equity multiplier: 2.2
Reading the result
- Below 1: the company relies more on equity than on debt, usually comfortable.
- 1 to 2: moderate leverage, common in manufacturing, telecoms and retail.
- Above 2: high leverage, normal for utilities, real estate and banks with steady cash flows, risky for cyclical businesses.
Always compare with companies in the same industry and look at the trend over several years. Pair the D/E ratio with the interest coverage ratio and the current ratio: a company with high debt but strong, stable earnings can be safer than one with little debt and volatile profits.
Pitfalls
Book equity can be small or negative after years of share buybacks, which makes the ratio look alarming for some very profitable companies. Leases are included as liabilities under current accounting standards, raising ratios for retailers and airlines compared with older reports. Analysts sometimes use market capitalization instead of book equity.