Definition of Debt to Equity Ratio (DER) and DER Formulas – Debt to Equity Ratio or the Capital Debt Ratio is a financial ratio that shows the relative proportion between Equity and Debt used to finance company assets.
This Debt to Equity Ratio is also known as the Leverage Ratio, which is the ratio used to measure how well the investment structure of a company.
Debt to Equity Ratio or DER is the main financial ratio and is used to assess a company’s financial position. This ratio is also a measure of a company’s ability to pay off obligations. This Debt to Equity Ratio is an important ratio to consider when examining the financial health of a company.
If the ratio increases, this means that the company is financed by creditors and not from its own financial sources which may be a fairly dangerous trend. Lenders and investors usually choose a low Debt to Equity Ratio because their interests are better protected if there is a decline in business at the company concerned.
Please to also read Debt Ratio definition and its Formula.
Debt to Equity Ratio (DER) formula
The debt to equity ratio (DER) is calculated by taking the total debt obligations (liabilities) and dividing them by equity. The following below is the Debt to Equity Ratio (DER) Formula.
Debt to Equity Ratio (DER) = Total Debt / Equity
- Debts or liabilities ( Liabilities ) is an obligation that must be paid in cash to the other party within a certain period. Based on the repayment period, these obligations or debts are usually classified as current liabilities, long-term liabilities, and other obligations.
- Equity ( Equity ) is the owner’s right to assets of a company that is net assets (total assets minus liabilities). Equity can consist of the company’s owner’s deposit and retained earnings.
Case Example of Calculation of Debt to Equity Ratio
Based on the second quarter financial statements as of June 30, 2014, ABCD Company, which is coded by the AB issuer, has a Liability of US $ 7 million and Equity of US $ 3 million. What is the Debt to Equity Ratio or DER of ABC company?
- Total Liabilities = US $ 7 million
- Total Equity = US $ 3 million
- Debt to Equity Ratio (DER) =?
- Debt to Equity Ratio (DER) = Total Liabilities / Total Equity
- Debt to Equity Ratio (DER) = US $ 7 million / US $ 3 million
- Debt to Equity Ratio (DER) = 2.33 times
So the ratio of Debt to Equity or Debt to Equity Ratio of ABC Company as per the second quarter financial statements dated June 30, 2014, is 2.33 times.
Debt to Equity Ratio
In general, the optimal Debt to Equity Ratio in a company is about 1 time, where the Amount of Debt is equal to the Amount of Equity.
However, this ratio differs from one industry to another because it depends on the proportion of current assets and non-current assets. The more non-current assets or assets (such as in capital-intensive industries), the more equity is needed to finance long-term investment.
For most companies, the acceptable Debt to Equity Ratio ranges between 1.5 times to 2 times. For large companies that have gone public (publicly listed companies), Debt to Equity Ratio can reach 2 times or more and is still considered “acceptable”. But for small and medium companies, this number is not acceptable.
In general, a high Debt to Equity Ratio indicates that a company may not be able to generate enough money to meet its debt obligations. However, a low Debt to Equity Ratio can also indicate that a company is not utilizing its profit maximally.
Debt to Equity Ratio (DER) is a fundamental analysis of shares.