Debt-to-Equity Ratio
Measures financial leverage by comparing borrowed funds to owner-supplied funds.
Formula
Variables
Example
Debt $300k / equity $200k = 1.5
How it works
The debt-to-equity ratio compares how much a business is financed by borrowing versus how much is financed by the owners. It works because total debt represents claims that must be repaid to lenders, while total equity represents the owners' residual stake after liabilities are accounted for. A higher ratio generally means the company is using more leverage, which can increase both potential returns and financial risk.
When to use it
Use this ratio when assessing a company's capital structure, borrowing dependence, or financial risk. It is especially useful for comparing firms in the same industry or for judging whether a business may be carrying too much debt relative to owner funding.
Worked example, step by step
Step 1: Identify total debt = $480,000 Step 2: Identify total equity = $320,000 Step 3: Apply the formula: D/E = Total Debt / Total Equity Step 4: D/E = 480,000 / 320,000 = 1.5 Step 5: Final answer: The debt-to-equity ratio is 1.5, meaning the company has $1.50 of debt for every $1.00 of equity.
Common mistakes to avoid
- Using only short-term debt instead of all liabilities or total debt
- Dividing equity by debt by accident and reversing the ratio
- Comparing companies from very different industries without context
Did You Know?
Higher leverage magnifies both gains and losses — a key reason banks watch this ratio closely.
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