Debt to Equity ratio is an indication of the business financial leverage, which compares level of debt and equity in the total financing means the business uses to finance its assets.
It is marked D/E ratio. The following Debt Equity Ratio formula is widely used:
Debt/Equity Ratio=Total Liabilities / Total Equity
While using this formula, which allows to understand how to calculate debt to equity ratio, we get percentage or number. Higher values of this ratio indicate higher leverage, leading to a conclusion that the business does have higher financial risk due to the fact that bigger share of the assets is being financed debt.
In the same way as for other ratios it is essential to analyze Debt to Equity ratio values across businesses operating in the same industry, since various industries may have their own financing trends and levels. Those businesses which operate in industry where high levels of capital investments are required tend to have higher Debt Equity ratio since more financial means are required to acquire property, plant and equipment.
Creditors and investors of course prefer lower ratios due to the fact that is such case there is less risk that the business will fail to pay its debt. Therefore those businesses with higher values of debt to equity ratio might face difficulties in getting additional capital for investments.
Also regarding calculation formula, the above one mentioned is very straightforward, where all liabilities are included. However the more precise calculation would be to take only real debt (long-term and short-term and also lease liabilities), which is directly related to investments, but not operations related like accounts payable to suppliers or payroll liabilities to employees.
Therefore the following Debt to Equity ratio formula is better, of course with the condition that there is a possibility to derive such data from financial statements:
Debt to Equity Ratio= (Long-term Debt+Short-term debt+Leasing Liabilities) / Equity