What Is the Debt-to-Equity Ratio?

The debt-to-equity ratio formula is fairly simple: 

Total liabilities / total shareholder's equity = debt-to-equity 

This ratio is typically expressed in numerical form, such as 0.6, 1.2, or 2.0. 

Total debt includes short-term and long-term liabilities. Short-term liabilities are debt that typically are paid off within a year—think rent, income taxes, and accounts payables. Long-term liabilities include any debt that is paid off in more than a year, typically things such as larger bank loans and bonds. 

If you use Excel sheets frequently for your business, you can easily punch in a formula to calculate a D/E ratio: 

1. Pop in the total debt and shareholder equity from the company’s balance sheet. 

2. Put these numbers side-by-side in two cells on a spreadsheet.

3. Last, in the cell to the left of these two cells, put X/Y to get the D/E ratio. 

For example: 

Total debt: Cell D24

Shareholder equity: Cell D25 

D/E Ratio (in Cell D23): D24/D25 

When a business has a D/E ratio that exceeds 1.0, it means that the company has more debt than assets. On the flip side, a D/E ratio of less than 1.0 shows a company's assets are greater than its debt load.

It's important to keep in mind that the D/E ratio has some limitations. For one, a business's leverage might be skewed by including or excluding preferred stock, contributions to retirement accounts, and so-called intangible assets. In turn, the ratio might not paint a complete or accurate picture of how much debt a company is actually carrying.

Sometimes, the calculations can feel like comparing apples to oranges; accounts in one company's balance sheet might look different or include different categories or transactions than another company's. In that case, adjustments might be made to the D/E ratios of different companies so they're more comparable.

Then there is the argument that leverage isn't enough to determine how risky a company might be for the investor. That's because leverage doesn't take into account low interest rates, which tend to make it less costly to borrow and repay debt.

A debt-to-equity ratio of 1.0 means that for every dollar of equity a company has, it uses $1 of debt to run the business. A debt-to-equity ratio of 2.0 means that for every $1 of equity a company has, it taps into $2 of financing. A debt-to-equity ratio of 0.75 equates to 75 cents borrowed for every $1 of equity.

Jennifer is an angel investor who has narrowed down to two the number of immersive art venues she wants to invest in. She takes a gander at the balance sheets of Snail Mail Art Unlimited and Pop Color Infusion. Snail Mail Art Unlimited has $40,000 in debt and $80,000 in assets—its D/E ratio is 0.50. Pop Color Infusion has $50,000 in debt and $50,000 in assets, which equates to a D/E ratio of 1.

Looking closely at Snail Mail Art Unlimited, Jennifer sees that it recently took out a loan to open a new venue, which could mean greater profitability in a few years. Meanwhile, Pop Color Infusion recently took out a bank loan because it needed the financing to cover outstanding invoices from vendors. While Snail Mail Art has long-term debt, Pop Color Infusion is carrying short-term debt. Although Pop Color's D/E ratio might change in the near future after it repays the loan, Snail Mail's D/E ratio might remain high for a while. That's because it might be years before it pays back the loan.

Defining a good debt-to-equity ratio is tricky because industry norms vary wildly. Plus, companies within the same industry, depending on their size, goods and services offered, and other variables could also lead to a different D/E ratio. However, across the board, if a company has a D/E ratio higher than  2.0, it’s a warning sign, regardless of industry.

Industries that require heavy capital investment tend to have higher D/E ratios than companies that sell services. For example, railroads and airlines spend a lot on materials and equipment, relying on borrowing that oftens leads to high D/E ratios. Amusement and entertainment companies, by comparison, tend to be less heavily indebted and have lower D/E readings.  

If a debt-to-equity ratio is too high or too low, it could be problematic. An excessive D/E ratio might indicate that a company could have a hard time repaying its debt if profits dwindle. Or should the company be in financial straits and file for bankruptcy, it could have a tough time landing traditional financing, which it relied on in the past to run and grow the business.

However, a low D/E ratio could indicate that a business relies too heavily on its own assets. Used properly, debt is a powerful tool to help a company grow faster than it otherwise might by relying on internal capital. There's a bit of a happy medium when it comes to how much debt a company should shoulder.