What Are the Steps to Calculating the Debt-to-Equity Ratio In Excel?
The debt-to-equity (D/E) ratio is an important leverage metric 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.
Key Takeaways:
- The debt-to-equity (D/E) ratio is a measure of the degree to which a company is financing its operations through debt.
- The ratio shows how able a company can cover its outstanding debts in the event of a business downturn.
- The D/E ratio is calculated by dividing total debt by total shareholder equity.
- A high D/E ratio is not always a bad indicator. A company might take on debt to expand or innovate.
Understanding the Debt-to-Equity Ratio
The D/E ratio is calculated by dividing total debt by total shareholder equity. Although it is a simple calculation, this ratio carries substantial weight. While the optimal ratio varies from industry to industry, companies with high D/E ratios are often considered a greater risk by investors and lending institutions. The more that operations are funded by borrowed money, the greater the risk of bankruptcy if business declines. Minimum payments on loans and other debts must still be met even if a business does not turn enough profit to meet its obligations due to economic downturn or simple market competition. For a highly leveraged company, a particularly bad quarter could end in disaster.
However, a high D/E ratio is not always a sign of poor business practices. In fact, a certain amount of debt can actually be the catalyst that allows a company to expand operations and generate additional income for both the business and its shareholders. Some industries, such as the auto and construction industries, typically have higher ratios than others because getting started and maintaining inventory are capital-intensive. Companies with intangible products, such as online services, may have lower standard D/E ratios. Therefore, it is important to considera company's historical ratio as well as the D/E ratiosof similar companies in the same industry when evaluating financial health.
A high D/E ratio is not always a bad indicator. Some debt can indicate that a company is using financing to expand or innovate.
Calculating the Debt-to-Equity Ratio in Excel
Business owners use a variety of software to trackD/E ratios and other financial metrics. To calculate this ratio in Excel, locate the total debt and total shareholder equity on the company's balance sheet. Input both figures into two adjacent cells, say B2 and B3. In cell B4, input the formula "=B2/B3" to obtain the D/E ratio.
An Example of the Debt-to-Equity Ratio
The owner of a bookshop wants to expand their business and plans to leverage existing capital by taking on an additional loan. Because the book sales industry is beset by new digital media, a business with a large amount of debt would be considered a risky prospect by creditors. However, upon reviewing the company's finances, the loan officer determines the company has debt totaling $60,000 and shareholder equity totaling $100,000. With a D/E ratio of 0.6, the business should be able to withstand additional outside funding without being too highly leveraged.
