Definition of the debt ratio • Benzinga
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Debt ratio (also known as the D / E ratio) is a formula used to measure the total expenses of a business relative to the total value of the business. A company’s total value, or equity, is the aggregate purchase value of the company’s shares. Examples of the type of overhead included in D / E ratios include, but are not limited to, the following:
- Debt service
- Unpaid bills
- Employee’s salary
- 401k contributions
- Office rental
Overheads and expenses eat away at company profits and reduce dividends for investors. This is the most obvious reason why investors prefer to buy stocks in companies that are not loaded with a high D / R ratio.
Debt ratio formula
Below, you will find a simple formula for calculating a company’s debt-to-equity ratio.
Total debt Ã· Total share value = Debt / equity ratio
Example of equation:
$ 10,000,000 in debt Ã· $ 25,000,000 total share value = 0.40 debt to equity ratio
Example of debt ratio
Financial analysts are very sensitive to D / E ratios as an indicator of the overall health of a company. That said, a high D / E ratio doesn’t necessarily mean a poorly run business. Shrewd analysts realize that the D / E ratio does not exist in a vacuum and will compare a company’s D / E ratio to that of similar companies in the same industry.
Some companies are heavily indebted because of the activity in which they are located. Real estate development, for example, typically forces developers to borrow heavily to finance projects before they become profitable. However, as long as the development company’s D / E ratio does not grossly exceed the industry average standard, an analyst can still consider this to be a solid investment.
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