Debt-to-equity (D/E) ratio

A company can finance its operations with capital supplied by shareholders, with borrowed funds or with both. The debt-to-equity ratio compares those sources and shows how heavily the business relies on creditors relative to the equity supporting it.

When to use it

• Answer the key performance question: “To what extent are we financing our business through debts versus equity?”
• Assess this KPI within the Financial perspective.
• Plan data collection, formula use, reporting frequency, and data-source requirements for this KPI.
• Compare results against the targets, benchmarks, examples, or trend guidance available for this KPI.

Origins

Debt-to-equity is a conventional leverage ratio that developed with balance-sheet analysis and the growth of corporate debt markets. Early financial analysts used ratios to assess creditor protection and capital structure; later corporate-finance theory clarified the trade-off among tax benefits, financial flexibility and distress risk. There is no single canonical definition, so analysts must state how they treat leases, preferred shares, cash and non-interest-bearing liabilities.

What it is

Perspective: Financial perspective.

Key performance question: To what extent are we financing our business through debts versus equity?

A company with high debt relative to equity is highly leveraged or geared. Borrowing is not inherently harmful: if invested capital earns more than its interest and associated cost, leverage can increase returns beyond what shareholder capital alone could produce.

Excessive leverage, however, makes earnings more sensitive to interest expense and can constrain the company during a downturn. Creditors and shareholders may prefer a lower ratio because the equity cushion offers greater protection in liquidation. Yet an unusually low ratio can also show that management is not using affordable debt to finance valuable growth. The objective is a resilient capital structure, not the lowest possible number.

Capital intensity and normal financing practice differ by industry, so compare the ratio with companies that have similar assets, risk and accounting treatment.

How to use it

Measurement

Data collection method