A debt-to-equity ratio is an assessment of the financial leverage for a business. It compares the company's total assets to its owners' equity. Company shareholders and potential creditors are among the stakeholders interested in your ratio.
The formula for debt-to-equity is the value of total assets at the end of a period divided by owners' equity at the end of the period. If a company has total debt of $350,000 and total equity of $250,000, for instance, the debt-to-equity formula is $350,000 divided by $250,000. The result is 1.4. Thus, the ratio is expressed as 1.4:1, which means the company has $1.40 in debt for every $1 of equity.
You can typically find the total debt amount on the company's periodic balance sheet. Alternatively, you can calculate the value of the total debt for the period by adding the various debt balances. Debt accounts include long-term debt, short-term debt and leases, when applicable. As an example, short-term debt of $100,000 plus long-term debt of $200,000 plus leases of $50,000 gives you a total debt of $350,000.
Owner's equity refers to the value of all shareholder holdings at a given point in time. You can find the owners' equity for a business on its periodic balance sheet. It is also typically depicted on a company's statement of owners' equity. This amount signals how much of the company's financial leverage comes from investors. High owners' equity generally means the company is less reliant on debt financing and more reliant on its equity investment and assets to generate revenue and cash.
The average debt-to-equity ratio for U.S. and international companies is 1.5:1, according to financial software provider ReadyRatios. Business operators typically try to limit their ratios to 1.5 or 2:1. However, your optimum debt-to-equity ratio depends on your company's business and finance strategies. Some companies borrow aggressively during periods of rapid expansion. Others prefer to maintain relatively low levels of debt to avoid cash flow restrictions. When looking at new financing options, consider the proposed debt-to-equity ratio. If you have total debt of $150,000, and you are looking at an additional $50,000, debt, your proposed debt is $200,000. With equity of $100,000, you would go from a 1.5:1 ratio to a 2:1 ratio with the new loan.