Debt-To-Equity Ratio Calculator

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Debt-To-Equity Ratio Calculator

Financial Calculators
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What is Debt to Equity Ratio?


The debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of shareholders' equity and debt used to finance a company's assets.


Closely related to leveraging, the ratio is also known as risk, gearing or leverage. The two components are often taken from the firm's balance sheet or statement of financial position (so-called book value), but the ratio may also be calculated using market values for both, if the company's debt and equity are publicly traded, or using a combination of book value for debt and market value for equity financially.


Usage

Preferred stock can be considered part of debt or equity. Attributing preferred shares to one or the other is partially a subjective decision but will also take into account the specific features of the preferred shares.


When used to calculate a company's financial leverage, the debt usually includes only the Long Term Debt (LTD). Quoted ratios can even exclude the current portion of the LTD. The composition of equity and debt and its influence on the value of the firm is much debated and also described in the Modigliani–Miller theorem.


Financial economists and academic papers will usually refer to all liabilities as debt, and the statement that equity plus liabilities equals assets is therefore an accounting identity (it is, by definition, true). Other definitions of debt to equity may not respect this accounting identity, and should be carefully compared. Generally speaking, a high ratio may indicate that the company is much resourced with (outside) borrowing as compared to funding from shareholders.


Formula

In a general sense, the ratio is simply debt divided by equity. However, what is classified as debt can differ depending on the interpretation used. Thus, the ratio can take on a number of forms including:

  •  Debt / Equity
  •  Long-term Debt / Equity
  •  Total Liabilities / Equity

In a basic sense, Total Debt / Equity is a measure of all of a company's future obligations on the balance sheet relative to equity. However, the ratio can be more discerning as to what is actually a borrowing, as opposed to other types of obligations that might exist on the balance sheet under the liabilities section. For example, often only the liabilities accounts that are actually labelled as "debt" on the balance sheet are used in the numerator, instead of the broader category of "total liabilities". In other words, actual borrowings like bank loans and interest-bearing debt securities are used, as opposed to the broadly inclusive category of total liabilities which, in addition to debt-labelled accounts, can include accrual accounts like unearned revenue.


Another popular iteration of the ratio is the long-term-debt-to-equity ratio which uses only long-term debt in the numerator instead of total debt or total liabilities. Total debt includes both long-term debt and short-term debt which is made up of actual short-term debt that has actual short-term maturities and also the portion of long-term debt that has become short-term in the current period because it is now nearing maturity. This second classification of short-term debt is carved out of long-term debt and is reclassified as a current liability called current portion of long-term debt (or a similar name). The remaining long-term debt is used in the numerator of the long-term-debt-to-equity ratio.


A similar ratio is debt-to-capital (D/C), where capital is the sum of debt and equity:

  • D/C = total liabilities / total capital = debt / (debt + equity)


The relationship between D/E and D/C is:

  • D/C = D/(D+E) = D/E / (1 + D/E)


The debt-to-total assets (D/A) is defined as:

  • D/A = total liabilities / total assets = debt / (debt + equity + non-financial liabilities)


In the financial industry (particularly banking), a similar concept is equity to total assets (or equity to risk-weighted assets), otherwise known as capital adequacy.


It is a problematic measure of leverage, because an increase in non-financial liabilities reduces this ratio. Nevertheless, it is in common use.


Background

On a balance sheet, the formal definition is that debt (liabilities) plus equity equals assets, or any equivalent reformulation. Both the formulas below are therefore identical:

  • A = D + E
  • E = A – D or D = A – E.


Debt to equity can also be reformulated in terms of assets or debt:

  • D/E = D /(A – D) = (A – E) / E.


Example

  •  Debt / equity: 4.304 (total debt / stockholder equity) (340/79). Note: This is often presented in percentage form, for instance 430.4.
  •  Equity ratio: 12% (shareholder equity / all equity) (79,180,000/647,483,000)
  •  Other equity / shareholder equity: 7.177 (568,303,000/79,180,000)


RELATED TOPIC

Cash ratio (read full article here)

The cash ratio is a measurement of a company's liquidity or ratio of a company's total cash and cash equivalents to its current liabilities. The metric calculates a company's ability to repay its short-term debt with cash or near-cash resources, such as easily marketable securities. This information is useful to creditors when they decide how much money, if any, they would be willing to loan a company.


The cash ratio is almost like an indicator of a firm’s value under the worst-case scenario—say, where the company is about to go out of business. The formula for the cash ratio uses current liabilities for the denominator and


 It tells creditors and analysts the value of current assets that could quickly be turned into cash, and what percentage of the company’s current liabilities these cash and near-cash assets could cover.


It is generally a more conservative look at a company's ability to cover its debts and obligations, because it sticks strictly to cash or cash-equivalent holdings—leaving other assets, including accounts receivable, out of the equation.


If a company's cash ratio is less than 1, there are more current liabilities than cash and cash equivalents. It means insufficient cash on hand exists to pay off short-term debt. This may not be bad news if the company has conditions that skew its balance sheets, such as lengthier-than-normal credit terms with its suppliers, efficiently-managed inventory, and very little credit extended to its customers.


The key difference lies with the numerator. The numerator of the cash ratio restricts the asset portion of the equation to only the most liquid of assets, such as cash on hand, demand deposits, and cash equivalents (sometimes referred to as marketable securities), like money market accounts funds, savings accounts, and T-bills. Accounts receivable, inventory, prepaid assets, and certain investments are not included in the cash ratio, as they are with other liquidity measurements. The rationale is that these items may require time and effort to find a buyer in the market. In addition, the amount of money received from the sale of any of these assets may be indeterminable.


If a company's cash ratio is greater than 1, the company has more cash and cash equivalents than current liabilities. In this situation, the company has the ability to cover all short-term debt and still have cash remaining. While that sounds responsible, a higher cash ratio does not necessarily reflect a company's strong performance, especially if it is significantly greater than the industry norm. High cash ratios may indicate that a company is inefficient in the utilization of cash or not maximizing the potential benefit of low-cost loans: Instead of investing in profitable projects, it's letting money stagnate in a bank account. It may also suggest that a company is worried about future profitability and is accumulating a protective capital cushion.


A cash ratio is expressed as a numeral, greater or less than 1. Upon calculating the ratio, if the result is equal to 1, the company has exactly the same amount of current liabilities as it does cash and cash equivalents pay off those debts.


In order words, if the company has enough cash & cash equivalents and marketable securities to cover for current liabilities, the cash ratio will result in an amount greater than 1; otherwise, less than 1.


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