Financial analysts and investors are often very interested in analyzing financial statements in order to carry out financial ratio analysis to understand a company’s economic health and to determine if an investment is considered worthwhile or not.
The debt-to-equity (D/E) ratio is determined by dividing a corporation’s total liabilities by its shareholder equity.
The debt-to-equity, or D/E ratio, is a financial leverage ratio that is frequently calculated and looked at. It is considered to be a gearing ratio. Gearing ratios are financial ratios that compare the owner’s equity or capital to debt, or funds borrowed by the company.
This ratio compares a company’s total liabilities to its shareholder equity. It is widely considered one of the most important corporate valuation metrics because it highlights a company’s dependence on borrowed funds and its ability to meet those financial obligations.
Because debt is inherently risky, lenders and investors tend to favor businesses with lower D/E ratios. For lenders, a low ratio means a lower risk of loan default. For shareholders, it means a decreased probability of bankruptcy in the event of an economic downturn. A company with a higher ratio than its industry average, therefore, may have difficulty securing additional funding from either source.
The debt-to-equity ratio is associated with risk: a higher ratio suggests higher risk and that the company is financing its growth with debt.