What Is Considered a High Debt-To-Equity (D/E) Ratio? (2024)

FAQs

What Is Considered a High Debt-To-Equity (D/E) Ratio? ›

Generally, a good debt-to-equity ratio is anything lower than 1.0. A ratio of 2.0 or higher is usually considered risky.

The maximum acceptable debt-to-equity ratio for more companies is between 1.5-2 or less. Large companies having a value higher than 2 of the debt-to-equity ratio is acceptable. 3. A debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations.

The lower value of the debt-to-equity ratio is considered favourable, as it indicates a reduced risk. So, if the ratio of debt to equity is 0.5, that means that the company has half its liabilities because it has equity.

Firms whose ratio is greater than 1.0 use more debt in financing their operations than equity. If the ratio is less than 1.0, they use more equity than debt. If a company has a ratio of 1.25, it uses $1.25 in debt financing for every $1 of debt financing.

D e b t t o E q u i t y r a t i o = T o t a l l i a b i l i t i e s T o t a l E q u i t y. A value of $1.75, therefore, indicates that for every dollar of equity, a firm uses $1.75 in debt to finance its assets. This ratio indicates that the business has more credit financing than the owner's financing.

The debt-to-equity (D/E) ratio is a metric that provides insight into a company's use of debt. In general, a company with a high D/E ratio is considered a higher risk to lenders and investors because it suggests that the company is financing a significant amount of its potential growth through borrowing.

Still, as a general rule of thumb, most companies aim for an equity ratio of around 50%. Companies with ratios ranging around 50% to 80% tend to be considered “conservative”, while those with ratios between 20% and 40% are considered “leveraged”.

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.

A good debt to equity ratio is around 1 to 1.5. However, the ideal debt to equity ratio will vary depending on the industry because 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 ratio is the number of times debt is to equity. Therefore, if a financial corporation's ratio is 2.5 it means that the debt outstanding is 2.5 times larger than their equity. Higher debt can result in volatile earnings due to additional interest expense as well as increased vulnerability to business downturns.

How do you fix a bad debt-to-equity ratio? ›

To lower your company's debt-to-equity ratio, you can pay down loans, increase profitability, improve inventory management and restructure debt.

The higher your debt-to-equity ratio, the worse the organization's financial situation might be. Having a high debt-to-equity ratio essentially means the company finances its operations through accumulating debt rather than funds it earns. Although this isn't always bad, it often indicates higher financial risk.

Is a Higher or Lower Debt-to-Equity Ratio Better? In general, a lower D/E ratio is preferred as it indicates less debt on a company's balance sheet.

An ideal debt to equity ratio is generally somewhere between 1 and 2 — Yet this all depends on the industry the business operates in. For example, capital-intensive sectors such as the manufacturing industries may require a larger amount of debt to finance their operations compared to an online business.

This ratio measures the amount of money a company has to write off as a bad debt expense compared to its net sales. In other words, it tells you what percentage of sales profit a company loses to unpaid invoices.

Walmart (WMT) has a mix of debt and equity in its capital structure. The retailer's (XRT) total debt, both short and long-term, is ~$56.6 billion. Its debt works out to 69.6% and 27.7% as a percentage of equity and total assets, respectively. Walmart is a blue-chip company.

A debt-to-equity ratio of 1.5 would indicate that the company in question has $1.50 of debt for every $1 of equity. To illustrate, suppose the company had assets of $2 million and liabilities of $1.2 million. Since equity is equal to assets minus liabilities, the company's equity would be $800,000.

If a company's D/E ratio is 1.0 (or 100%), that means its liabilities are equal to its shareholders' equity. Anything higher than 1 indicates that a company relies more heavily on loans than equity to finance its operations.

A debt-to-equity ratio of 0.8 means the firm has $0.80 of debt for every $1 of equity. A debt-to-equity ratio of 0.8 means the firm finances 80 percent of its assets with debt and the other 20 percent with equity.