Debt to Equity Ratio: A Measure of a Company’s Financial Leverage and Risk
The debt-to-equity ratio is a financial metric that indicates the proportion of a company’s financing that comes from debt compared to the financing that comes from equity. It is commonly used to assess a company’s financial leverage or risk profile.
Debt to equity formula
The formula for calculating the debt-to-equity ratio is:
Debt-to-Equity Ratio = Total Debt / Total Equity
The debt-to-equity ratio provides insight into how a company is funded. A high debt-to-equity ratio suggests that a significant portion of the company’s financing comes from debt, which can increase financial risk. If the company experiences financial difficulties or faces challenges in meeting its debt obligations, it might struggle to remain solvent. On the other hand, a lower debt-to-equity ratio indicates a lower level of debt relative to equity, which may indicate a more conservative financing structure.
An D/E ratio of 2 or higher is deemed risky, particularly when the debt is being used to fund contracting activities.
Other factors to consider in debt financing is the size of loans, corporate bonds issues, maturity of debt, interest and coupons.