What is the debt to equity ratio? | AccountingCoach (2024)

FAQs

What is the debt to equity ratio? | AccountingCoach? ›

Definition of Debt to Equity Ratio

Generally, a good debt ratio is around 1 to 1.5. However, the ideal debt ratio will vary depending on the industry, as some industries use more debt financing than others. Capital-intensive industries like the financial and manufacturing industries often have higher ratios that can be greater than 2.

The debt-to-equity (D/E) ratio is used to evaluate a company's financial leverage and is calculated by dividing a company's total liabilities by its shareholder equity.

Generally, a lower ratio is better, as it implies that the company is in less debt and is less risky for lenders and investors. A debt-to-equity ratio of 0.5 or below is considered good.

The more debt you have, the higher your ratio will be. A ratio of roughly 2 or 2.5 is considered good, but anything higher than that is considered unfavorable.

The optimal debt-to-equity ratio will tend to vary widely by industry, but the general consensus is that it should not be above a level of 2.0. While some very large companies in fixed asset-heavy industries (such as mining or manufacturing) may have ratios higher than 2, these are the exception rather than the rule.

Ways to reduce debt-to-equity ratio

One of the most effective ways to do this is to increase revenue. Then, as your company's equity increases, you can use the funds to pay off debts or purchase new assets, thereby keeping your debt-to-equity ratio stable. Effective inventory management is also important.

A negative debt-to-equity ratio indicates that the company has more liabilities than assets. The company would be seen as extremely risky and or at risk of bankruptcy.

In general, many investors look for a company to have a debt ratio between 0.3 and 0.6. From a pure risk perspective, debt ratios of 0.4 or lower are considered better, while a debt ratio of 0.6 or higher makes it more difficult to borrow money.

35% or less: Looking Good - Relative to your income, your debt is at a manageable level. You most likely have money left over for saving or spending after you've paid your bills. Lenders generally view a lower DTI as favorable.

How much debt is healthy? ›

Ideally, financial experts like to see a DTI of no more than 15 to 20 percent of your net income. For example, a family with a $250 car payment and $100 of monthly credit card payments, and $2,500 net income per month would have a DTI of 14 percent ($350/$2,500 = 0.14 or 14%).

Walmart's debt / equity for fiscal years ending January 2020 to 2024 averaged 80.4%. Walmart's operated at median debt / equity of 78.6% from fiscal years ending January 2020 to 2024.

The average D/E ratio among S&P 500 companies is approximately 1.5. A ratio lower than 1 is considered favorable since that indicates a company is relying more on equity than on debt to finance its operating costs.

The average D/E ratio of major companies in the U.S. airline industry was between 5-6x in 2021, which indicates that for every $1 of shareholders' equity, the average company in the industry has more than $5 in total liabilities.

A debt ratio between 30% and 36% is also considered good. It's when you're approaching 40% that you have to be very, very vigilant. With a threshold like that, you're a greater risk to lenders. You may already be having trouble making your payments each month.

Interpreting the Debt Ratio

If the ratio is over 1, a company has more debt than assets. If the ratio is below 1, the company has more assets than debt. Broadly speaking, ratios of 60% (0.6) or more are considered high, while ratios of 40% (0.4) or less are considered low.

With a debt to equity ratio of 1.2, investing is less risky for the lenders because the business is not highly leveraged — meaning it isn't primarily financed with debt.

This compares annual payments to service all consumer debts—excluding mortgage payments—divided by your net income. This should be 20% or less of net income. A ratio of 15% or lower is healthy, and 20% or higher is considered a warning sign.