Definition of Debt to Equity (D/E)

Debt to Equity (D/E) is a vital financial measure which shows the ratio of debt owed by a company compared to the equity value of the company. The calculation for debt to equity is:

• Total Liabilities / Shareholders Equity

The actual calculation is open to interpretation as preferred shares can count as either debt or equity, and therefore someone working on valuation can manipulate the figures to meet the appropriate multiple requirements.

It is common for only long term debt requiring interest payments to be considered, as short term debt is quite common in most companies and usually does not affect the value of long term prospects.

Higher ratios of debt to equity can indicate that the company is financing much of its activities through borrowing, and is highly sensitive to the money markets and interest rates. However, this can benefit shareholders if the increase in earnings is greater than the interest payments on the debt (i.e. if the debt is sustainable).

Debt to equity is frequently included in loan agreements as a covenant saying that the firm must remain above a certain debt to equity ratio, or else must pay back the loan.

Debt to equity values can only be compared within industries, as an 'acceptable' level of debt relative to equity is likely to vary across industries.