If a company’s D/E ratio significantly exceeds those of others in its industry, then its stock could be more risky. If interest rates are higher when the long-term debt comes due and needs to be refinanced, then interest expense will rise. We can see below that for Q1 2024, ending Dec. 30, 2023, Apple had total liabilities of $279 billion and total shareholders’ equity of $74 billion.
How to calculate the debt-to-equity ratio
There is no universally agreed upon “ideal” D/E ratio, though generally, investors want it to be 2 or lower. These industry-specific factors definitely matter when it comes to assessing D/E. Of note, there is no “ideal” D/E ratio, though investors generally like it account definition and meaning to be below about 2. We’ll now move to a modeling exercise, which you can access by filling out the form below. Lenders and investors perceive borrowers funded primarily with equity (e.g. owners’ equity, outside equity raised, retained earnings) more favorably.
Everything You Need To Master Financial Modeling
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. The debt-to-equity ratio (D/E) is a financial leverage ratio that can be helpful when attempting to understand a company’s economic health and if an investment is worthwhile or not. It is considered to be a gearing ratio that compares the owner’s equity or capital to debt, or funds borrowed by the company. Debt-financed growth may serve to increase earnings, and if the incremental profit increase exceeds the related rise in debt service costs, then shareholders should expect to benefit.
How to Calculate Debt-to-Equity Ratio
A high ratio may indicate the company is more vulnerable to economic downturns or interest rate fluctuations, while a low ratio may suggest financial stability and flexibility. Let’s calculate the Debt-to-Equity Ratio of the leading sports brand in the world, NIKE Inc. The latest available annual financial statements are for the period ending May 31, 2022. The D/E ratio indicates how reliant a company is on debt to finance its operations.
- Debt-financed growth may serve to increase earnings, and if the incremental profit increase exceeds the related rise in debt service costs, then shareholders should expect to benefit.
- If a bank is deciding to give this company a loan, it will see this high D/E ratio and will only offer debt with a higher interest rate in order to be compensated for the risk.
- Thus, in this variation, short-term debt is not included in the long-term debt-to-equity calculation.
In all cases, D/E ratios should be considered relative to a company’s industry and growth stage. Generally, the debt-to-equity ratio is calculated as total debt divided by shareholders’ equity. But, more specifically, the classification of debt may vary depending on the interpretation. Gearing ratios are financial ratios that indicate how a company is using its leverage. In the banking and financial services sector, a relatively high D/E ratio is commonplace.
As we can see, NIKE, Inc.’s Debt-to-Equity ratio slightly decreased year-over-year, primarily attributable to increased shareholders’ equity balance. A higher debt-equity ratio indicates a levered firm, which is quite preferable for a company that is stable with significant cash https://www.kelleysbookkeeping.com/ flow generation, but not preferable when a company is in decline. Conversely, a lower ratio indicates a firm less levered and closer to being fully equity financed. What counts as a “good” debt-to-equity (D/E) ratio will depend on the nature of the business and its industry.
When using the D/E ratio, it is very important to consider the industry in which the company operates. Because different industries have different capital needs and growth rates, a D/E ratio value that’s common in one industry might be a red flag in another. Gearing ratios constitute a broad category of financial ratios, of which the D/E ratio is the best known.
If a D/E ratio becomes negative, a company may have no choice but to file for bankruptcy. If the D/E ratio of a company is negative, it means the liabilities are greater than the assets. They may note that the company has a high D/E ratio and conclude that the risk is too high.
Because equity is equal to assets minus liabilities, the company’s equity would be $800,000. By contrast, higher D/E ratios imply the company’s operations depend more on debt capital – which means creditors have greater claims on the assets of the company in a liquidation scenario. In general, if a company’s D/E ratio is too high, that signals that the company is at risk of financial distress (i.e. at risk of being unable to meet required debt obligations). If a bank is deciding to give this company a loan, it will see this high D/E ratio and will only offer debt with a higher interest rate in order to be compensated for the risk.
It is a measure of the degree to which a company is financing its operations with debt rather than its own resources. The debt-to-equity ratio is calculated by dividing a company’s total liabilities by its total shareholder equity. Liabilities and shareholder equity can be found on the balance sheet, which is a financial statement that lists a company’s assets, liabilities and https://www.kelleysbookkeeping.com/internal-control/ stockholders’ equity at a particular point in time. Both of these values can be found on a company’s balance sheet, which is a financial statement that details the balances for each account. When evaluating a company’s financial health, you can use several liquidity ratios. One is the debt-to-equity (D/E) ratio, which compares total liabilities to total shareholder equity.