{"id":384,"date":"2024-09-06T16:49:19","date_gmt":"2024-09-06T16:49:19","guid":{"rendered":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/chapter\/debt-to-equity-ratio\/"},"modified":"2024-09-11T20:13:59","modified_gmt":"2024-09-11T20:13:59","slug":"debt-to-equity-ratio","status":"publish","type":"chapter","link":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/chapter\/debt-to-equity-ratio\/","title":{"raw":"Debt to Equity Ratio","rendered":"Debt to Equity Ratio"},"content":{"raw":"<section class=\"textbox learningGoals\" aria-label=\"Learning Goals\">\r\n<ul>\r\n \t<li>Calculate the debt to equity ratio<\/li>\r\n<\/ul>\r\n<\/section>&nbsp;\r\n\r\nThe debt-to-equity (D\/E) ratio is calculated by dividing a company\u2019s total liabilities by its shareholder equity:\r\n<p style=\"padding-left: 30px;\">[latex]\\left(\\dfrac{\\text{company\u2019s total liabilities}}{\\text{shareholder equity}}\\right)[\/latex]<\/p>\r\nThese numbers are available on the balance sheet of a company\u2019s financial statements.\r\n\r\nThe ratio is used to evaluate a company's financial leverage. The D\/E ratio is an important metric used in corporate finance. It is a measure of the degree to which a company is financing its operations through debt versus wholly-owned funds. More specifically, it reflects the ability of shareholder equity to cover all outstanding debts in the event of a business downturn.\r\n\r\nAssets are acquired either by investments from stockholders or through borrowing from other parties. Companies that are averse to debt would prefer a lower ratio. Companies that prefer to use \u201cother people\u2019s money\u201d to finance assets would favor a higher ratio.\r\n\r\nIn the Jonick example, debt is 1.275 million and equity is 2.675 million.\r\n<p style=\"padding-left: 30px;\">[latex]\\dfrac{1.275\\text{ million}}{2.675\\text{ million}}=.47663551\\approx0.5[\/latex]<\/p>\r\nThis gives us a ratio of debt to equity of .47663551, or rounded to the nearest tenth, about 0.5, which could be stated as either 50% or \u00bd.\r\n<table class=\"fin-table acctstatement\"><caption>Jonick Company\r\nComparative Balance Sheet\r\nDecember 31, 2019 and 2018<\/caption>\r\n<tbody>\r\n<tr>\r\n<th><\/th>\r\n<th scope=\"col\">2019<\/th>\r\n<\/tr>\r\n<tr>\r\n<td colspan=\"2\"><span style=\"text-transform: uppercase;\"><strong>Liabilities<\/strong><\/span><\/td>\r\n<\/tr>\r\n<tr>\r\n<td colspan=\"2\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Current liabilities:<\/strong><\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Accounts payable<\/td>\r\n<td class=\"r\">$120,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Salaries payable<\/td>\r\n<td class=\"r\">244,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>\u00a0 \u00a0 \u00a0 <strong>Total current liabilities<\/strong><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>$364,000<\/td>\r\n<\/tr>\r\n<tr aria-hidden=\"true\">\r\n<td colspan=\"2\"><\/td>\r\n<\/tr>\r\n<tr>\r\n<td colspan=\"2\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Long-term liabilities<\/strong><\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Mortgage note payable<\/td>\r\n<td class=\"r\">$83,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Bonds payable<\/td>\r\n<td class=\"r\">828,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>\u00a0 \u00a0 \u00a0 <strong>Total long-term liabilities<\/strong><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>$911,000<\/td>\r\n<\/tr>\r\n<tr class=\"highlight\">\r\n<td>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0<strong>Total liabilities<\/strong><\/td>\r\n<td class=\"r line-double line-single\"><span class=\"u-sr-only\">Single Line<\/span>$1,275,000<span class=\"u-sr-only\">Double Line<\/span><\/td>\r\n<\/tr>\r\n<tr aria-hidden=\"true\">\r\n<td colspan=\"2\"><\/td>\r\n<\/tr>\r\n<tr>\r\n<td colspan=\"2\"><span style=\"text-transform: uppercase;\"><strong>Stockholders' Equity<\/strong><\/span><\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Preferred $1.50 stock, $20 par<\/td>\r\n<td class=\"r\">$166,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Common stock, $10 par<\/td>\r\n<td class=\"r\">83,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Retained earnings<\/td>\r\n<td class=\"r\">2,426,000<\/td>\r\n<\/tr>\r\n<tr class=\"highlight\">\r\n<td>\u00a0 \u00a0 \u00a0 <strong>Total stockholders' equity<\/strong><\/td>\r\n<td class=\"r\">$2,675,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td><strong>Total liabilities and stockholders' equity<\/strong><\/td>\r\n<td class=\"r line-double line-single\"><span class=\"u-sr-only\">Single Line<\/span>$3,950,000<span class=\"u-sr-only\">Double Line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nIf a company prefers to use borrowed money (leverage) to finance its operations, it would not be alarmed at a 1:1 ratio, or maybe even 2:1 ($2 of borrowed funds for every $1 of owner contributed capital, including retained earnings). Jonick has a ratio of 0.5:1, which could also be stated more clearly as 1:2, which means the company has only $1 of debt for every $2 of owner investment. Looking at this from a total asset standpoint, it means that for every $3 in total assets, $1 is debt financed and $2 is owner financed.\r\n\r\nIf you think of this in terms of a home purchase of say $300,000, it would mean that you have invested $200,000 of your own money and borrowed $100,000 from the bank. A ratio of 5:1, on the other hand, would mean that the homeowner had borrowed $250,000 and put $50,000 of her own money into the purchase.\r\n\r\nSo, if as an investor or business owner, you prefer to leverage (use the bank\u2019s money to fund) your business, you would be looking at higher debt to equity ratios. If you prefer not to borrow, like Jonick, you would be expecting lower D\/E indicators.\r\n\r\nNow let's practice what you've learned.\r\n\r\n<section class=\"textbox tryIt\" aria-label=\"Try It\">[ohm2_question hide_question_numbers=1]25259[\/ohm2_question]<\/section>","rendered":"<section class=\"textbox learningGoals\" aria-label=\"Learning Goals\">\n<ul>\n<li>Calculate the debt to equity ratio<\/li>\n<\/ul>\n<\/section>\n<p>&nbsp;<\/p>\n<p>The debt-to-equity (D\/E) ratio is calculated by dividing a company\u2019s total liabilities by its shareholder equity:<\/p>\n<p style=\"padding-left: 30px;\">[latex]\\left(\\dfrac{\\text{company\u2019s total liabilities}}{\\text{shareholder equity}}\\right)[\/latex]<\/p>\n<p>These numbers are available on the balance sheet of a company\u2019s financial statements.<\/p>\n<p>The ratio is used to evaluate a company&#8217;s financial leverage. The D\/E ratio is an important metric used in corporate finance. It is a measure of the degree to which a company is financing its operations through debt versus wholly-owned funds. More specifically, it reflects the ability of shareholder equity to cover all outstanding debts in the event of a business downturn.<\/p>\n<p>Assets are acquired either by investments from stockholders or through borrowing from other parties. Companies that are averse to debt would prefer a lower ratio. Companies that prefer to use \u201cother people\u2019s money\u201d to finance assets would favor a higher ratio.<\/p>\n<p>In the Jonick example, debt is 1.275 million and equity is 2.675 million.<\/p>\n<p style=\"padding-left: 30px;\">[latex]\\dfrac{1.275\\text{ million}}{2.675\\text{ million}}=.47663551\\approx0.5[\/latex]<\/p>\n<p>This gives us a ratio of debt to equity of .47663551, or rounded to the nearest tenth, about 0.5, which could be stated as either 50% or \u00bd.<\/p>\n<table class=\"fin-table acctstatement\">\n<caption>Jonick Company<br \/>\nComparative Balance Sheet<br \/>\nDecember 31, 2019 and 2018<\/caption>\n<tbody>\n<tr>\n<th><\/th>\n<th scope=\"col\">2019<\/th>\n<\/tr>\n<tr>\n<td colspan=\"2\"><span style=\"text-transform: uppercase;\"><strong>Liabilities<\/strong><\/span><\/td>\n<\/tr>\n<tr>\n<td colspan=\"2\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Current liabilities:<\/strong><\/td>\n<\/tr>\n<tr>\n<td>Accounts payable<\/td>\n<td class=\"r\">$120,000<\/td>\n<\/tr>\n<tr>\n<td>Salaries payable<\/td>\n<td class=\"r\">244,000<\/td>\n<\/tr>\n<tr>\n<td>\u00a0 \u00a0 \u00a0 <strong>Total current liabilities<\/strong><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>$364,000<\/td>\n<\/tr>\n<tr aria-hidden=\"true\">\n<td colspan=\"2\"><\/td>\n<\/tr>\n<tr>\n<td colspan=\"2\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Long-term liabilities<\/strong><\/td>\n<\/tr>\n<tr>\n<td>Mortgage note payable<\/td>\n<td class=\"r\">$83,000<\/td>\n<\/tr>\n<tr>\n<td>Bonds payable<\/td>\n<td class=\"r\">828,000<\/td>\n<\/tr>\n<tr>\n<td>\u00a0 \u00a0 \u00a0 <strong>Total long-term liabilities<\/strong><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>$911,000<\/td>\n<\/tr>\n<tr class=\"highlight\">\n<td>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0<strong>Total liabilities<\/strong><\/td>\n<td class=\"r line-double line-single\"><span class=\"u-sr-only\">Single Line<\/span>$1,275,000<span class=\"u-sr-only\">Double Line<\/span><\/td>\n<\/tr>\n<tr aria-hidden=\"true\">\n<td colspan=\"2\"><\/td>\n<\/tr>\n<tr>\n<td colspan=\"2\"><span style=\"text-transform: uppercase;\"><strong>Stockholders&#8217; Equity<\/strong><\/span><\/td>\n<\/tr>\n<tr>\n<td>Preferred $1.50 stock, $20 par<\/td>\n<td class=\"r\">$166,000<\/td>\n<\/tr>\n<tr>\n<td>Common stock, $10 par<\/td>\n<td class=\"r\">83,000<\/td>\n<\/tr>\n<tr>\n<td>Retained earnings<\/td>\n<td class=\"r\">2,426,000<\/td>\n<\/tr>\n<tr class=\"highlight\">\n<td>\u00a0 \u00a0 \u00a0 <strong>Total stockholders&#8217; equity<\/strong><\/td>\n<td class=\"r\">$2,675,000<\/td>\n<\/tr>\n<tr>\n<td><strong>Total liabilities and stockholders&#8217; equity<\/strong><\/td>\n<td class=\"r line-double line-single\"><span class=\"u-sr-only\">Single Line<\/span>$3,950,000<span class=\"u-sr-only\">Double Line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>If a company prefers to use borrowed money (leverage) to finance its operations, it would not be alarmed at a 1:1 ratio, or maybe even 2:1 ($2 of borrowed funds for every $1 of owner contributed capital, including retained earnings). Jonick has a ratio of 0.5:1, which could also be stated more clearly as 1:2, which means the company has only $1 of debt for every $2 of owner investment. Looking at this from a total asset standpoint, it means that for every $3 in total assets, $1 is debt financed and $2 is owner financed.<\/p>\n<p>If you think of this in terms of a home purchase of say $300,000, it would mean that you have invested $200,000 of your own money and borrowed $100,000 from the bank. A ratio of 5:1, on the other hand, would mean that the homeowner had borrowed $250,000 and put $50,000 of her own money into the purchase.<\/p>\n<p>So, if as an investor or business owner, you prefer to leverage (use the bank\u2019s money to fund) your business, you would be looking at higher debt to equity ratios. If you prefer not to borrow, like Jonick, you would be expecting lower D\/E indicators.<\/p>\n<p>Now let&#8217;s practice what you&#8217;ve learned.<\/p>\n<section class=\"textbox tryIt\" aria-label=\"Try It\"><iframe loading=\"lazy\" id=\"ohm25259\" class=\"resizable\" src=\"https:\/\/ohm.one.lumenlearning.com\/multiembedq.php?id=25259&theme=lumen&iframe_resize_id=ohm25259&source=tnh\" width=\"100%\" height=\"150\"><\/iframe><\/section>\n","protected":false},"author":6,"menu_order":22,"template":"","meta":{"_candela_citation":"[{\"type\":\"original\",\"description\":\"Debt to Equity Ratio\",\"author\":\"Joseph Cooke\",\"organization\":\"Lumen Learning\",\"url\":\"\",\"project\":\"\",\"license\":\"cc-by\",\"license_terms\":\"\"},{\"type\":\"cc\",\"description\":\"Principles of Financial Accounting\",\"author\":\"Christine Jonick\",\"organization\":\"\",\"url\":\"https:\/\/web.ung.edu\/media\/university-press\/Principles-of-Financial-Accounting.pdf?t=1601063299615\",\"project\":\"\",\"license\":\"cc-by-sa\",\"license_terms\":\"\"}]","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"part":362,"module-header":"- Select Header -","content_attributions":[{"type":"original","description":"Debt to Equity Ratio","author":"Joseph Cooke","organization":"Lumen Learning","url":"","project":"","license":"cc-by","license_terms":""},{"type":"cc","description":"Principles of Financial Accounting","author":"Christine Jonick","organization":"","url":"https:\/\/web.ung.edu\/media\/university-press\/Principles-of-Financial-Accounting.pdf?t=1601063299615","project":"","license":"cc-by-sa","license_terms":""}],"internal_book_links":[],"video_content":null,"cc_video_embed_content":{"cc_scripts":"","media_targets":[]},"try_it_collection":null,"_links":{"self":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/384"}],"collection":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/users\/6"}],"version-history":[{"count":3,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/384\/revisions"}],"predecessor-version":[{"id":979,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/384\/revisions\/979"}],"part":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/parts\/362"}],"metadata":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/384\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/media?parent=384"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapter-type?post=384"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/contributor?post=384"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/license?post=384"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}