debt-to-equity ratio
A financial leverage ratio comparing a company's total debt to shareholders' equity, measuring how much debt is used to finance operations relative to equity.
Example
“A debt-to-equity ratio of 2.0 means the company uses $2 of debt for every $1 of shareholder equity.”
Memory Tip
D/E ratio = debt divided by equity. Higher = more leveraged (riskier). Lower = more conservatively financed.
Why It Matters
Understanding debt-to-equity ratio helps you assess whether a company or investment is financially stable and sustainable. A high ratio might indicate increased financial risk, which could affect your investment returns or job security if you work at that company.
Common Misconception
Many people believe that any debt is bad and that a zero debt-to-equity ratio is always ideal. In reality, some debt can be healthy and help companies grow, so a moderate ratio often indicates smart financial management rather than reckless borrowing.
In Practice
Consider Company A with 500,000 dollars in total debt and 1,000,000 dollars in shareholders equity, giving it a debt-to-equity ratio of 0.5. Compare this to Company B with 2,000,000 dollars in debt and 1,000,000 dollars in equity, resulting in a ratio of 2.0, which signals that Company B is using twice as much debt relative to equity to finance operations.
Etymology
DEBT (borrowed money) TO (divided by) EQUITY (owner's capital) RATIO. How much DEBT versus EQUITY funds the company.
Common Misspellings
Small business accounting made simple
Related Terms
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See Also
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