# Debt to Equity

## The debt-to-equity ratio (D/E) indicates the relative proportion of shareholder's equity and debt used to finance a company's assets.

#### Key Points

• 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.

• Preferred stocks can be considered part of debt or equity. Attributing preferred shares to one or the other is partially a subjective decision.

• The formula of debt/ equity ratio: D/E = Debt (liabilities) / equity = Debt / (Assets – Debt) = (Assets – Equity) / Equity.

#### Terms

• The use of borrowed funds with a contractually determined return to increase the ability of a business to invest and earn an expected higher return (usually at high risk).

#### Figures

1. ##### Leverage Ratios of Investment Banks

Each of the five largest investment banks took on greater risk leading up to the subprime crisis. This is summarized by their leverage ratio, which is the ratio of total debt to total equity. A higher ratio indicates more risk.

## Debt to Equity

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. However, 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."Figure 1"

Preferred stocks 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.

Financial analysts and stock market quotes will generally not include other types of liabilities, such as accounts payable, although some will make adjustments to include or exclude certain items from the formal financial statements. Adjustments are sometimes also made, for example, to exclude intangible assets, and this will affect the formal equity; debt to equity (dequity) will therefore also be affected.

The formula of debt/equity ratio: D/E = Debt (liabilities) / equity. Sometimes only interest-bearing long-term debt is used instead of total liabilities in the calculation.

A similar ratio is the ratio of 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 asD/A = total liabilities / total assets = debt / (debt + equity + non-financial liabilities)

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 + EE = 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

#### Key Term Glossary

asset
Something or someone of any value; any portion of one's property or effects so considered.
##### Appears in these related concepts:
balance sheet
A summary of a person's or organization's assets, liabilities and equity as of a specific date.
##### Appears in these related concepts:
capital
Money and wealth; the means to acquire goods and services, especially in a non-barter system.
##### Appears in these related concepts:
debt
Money that the borrowing entity owes or is required to pay to a lender.
##### Appears in these related concepts:
Debt
An obligation owed by one party (the debtor) to a second party
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equity
Ownership, especially in terms of net monetary value, of a business.
##### Appears in these related concepts:
Equity
The residual claim or interest to investors in assets after all liabilities are paid. If liability exceeds assets, negative equity exists and can be purchased through stock.
##### Appears in these related concepts:
finance
To provide or obtain funding for a transaction or undertaking; to back; to support.
##### Appears in these related concepts:
financial leverage
any technique to multiply gains and losses, such as by borrowing
##### Appears in these related concepts:
financial statement
A formal record of all relevant financial information of a business, person, or other entity, presented in a structured and standardized manner to allow easy understanding.
##### Appears in these related concepts:
intangible assets
Intangible assets are defined as identifiable non-monetary assets that cannot be seen, touched or physically measured, and are created through time and effort, and are identifiable as a separate asset.
##### Appears in these related concepts:
Intangible assets
Intangible assets are defined as identifiable non-monetary assets that cannot be seen, touched, or physically measured. They are created through time and effort, and are identifiable as a separate asset.
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interest
The price paid for obtaining, or price received for providing, money or goods in a credit transaction, calculated as a fraction of the amount or value of what was borrowed.
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leverage
The use of borrowed funds with a contractually determined return to increase the ability of a business to invest and earn an expected higher return (usually at high risk).
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Leverage
Debt taken on by a firm in order to finance assets.
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liabilities
An amount of money in a company that is owed to someone and has to be paid in the future, such as tax, debt, interest, and mortgage payments.
##### Appears in these related concepts:
liability
An obligation, debt or responsibility owed to someone.
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market value
The total value of the company as traded in the market. Calculated by multiplying the number of shares outstanding by the price per share.
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preferred stock
Stock with a dividend, usually fixed, that is paid out of profits before any dividend can be paid on common stock. It also has priority to common stock in liquidation.
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Preferred stock
Preferred stock (also called preferred shares, preference shares or simply preferreds) is an equity security with properties of both an equity and a debt instrument, and is generally considered a hybrid instrument.
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Preferred Stock
Preferred stock is an equity security that has the properties of both an equity and debt instrument and is higher ranking than common stock.
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proportion
A quantity of something that is part of the whole amount or number.
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ratio
A number representing a comparison between two things.
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risk
The potential (conventionally negative) impact of an event, determined by combining the likelihood of the event occurring with the impact, should it occur.
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Risk
The potential that a chosen action or activity (including the choice of inaction) will lead to a loss (an undesirable outcome).
##### Appears in these related concepts:
shareholder
One who owns shares of stock.
##### Appears in these related concepts:
Shareholder
A shareholder legally owns at least one share of stock in a company, and has rights with regards to the company because of this
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stock
The capital raised by a company through the issue of shares. The total of shares held by an individual shareholder.
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Stock
The stock of a company represents the original capital paid into the business by its founders. It serves as a security for investors.
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stock market
A market for the trading of company stock.