The debt-to-equity (D/E) ratio is a leverage ratio that shows how much a company's financing comes from debt or equity. A higher D/E ratio means that more of a company's financing is from debt versus issuing shares of equity. Banks tend to have higher D/E ratios because they borrow capital in order to lend to customers. They also have substantial fixed assets, i.e., local branches, for example.
Calculating the D/E Ratio
The D/E ratio is calculated as total liabilities divided by total shareholders' equity. For example, if, as per thebalance sheet, the total debt of a business is worth $60 million and the total equity is worth $130 million, then the debt-to-equity is 0.46. In other words, for every dollar in equity, the firm has 46 cents in leverage. A ratio of 1 indicates that creditors and investors are balanced with respect to the company’s assets. The D/Eratio is considered a key financial metric because it indicates potential financial risk.
The D/E Ratio and Risk
A relatively high D/E ratio commonly indicates an aggressive growth strategy by a company because it has taken on debt. For investors, this means potentially increased profits with a correspondingly increased risk of loss. If the extra debt that the company takes on enables it to increase net profits by an amount greater than the interest cost of the additional debt, then the company should deliver a higher return on equity (ROE) to investors.
However, if the interest cost of the extra debt does not lead to a significant increase in revenues, the additional debt burden would reduce the company's profitability. In a worst-case scenario, it could overwhelm the company financially and result in insolvency and eventual bankruptcy.
What Level of Debt-to-Equity Is Considered Desirable?
A high debt-to-equity ratio is not always detrimental to a company's profits. If the company can demonstrate that it has sufficient cash flow to service its debt obligations and the leverage is increasing equity returns, that can be a sign of financial strength. In this case, taking on more debt and increasing the D/E ratio boosts the company’s ROE.Using debt instead of equity means that the equity account is smaller and the return on equity is higher.
Bank of America's D/E ratio for the three months ending March 31, 2019, was0.96. In March 2009, during the financial crisis, the ratio reached 2.65, according to Macrotrends.
Typically, the cost of debt is lower than thecost of equity. Therefore, another advantage in increasing the D/E ratio is that a firm’s weighted average cost of capital (WACC), or the average rate that a company is expected to pay its security holders to finance its assets, goes down.
Overall, however, a D/E ratio of 1.5 or lower is considered desirable, and a ratio higher than 2 is considered less favorable. D/E ratios vary significantly between industries, so investors should compare the ratios of similar companies in the same industry.
In the banking and financial services sector, a relatively high D/E ratio is commonplace. Banks carry higher amounts of debt because they own substantial fixed assets in the form of branch networks.
FAQs
Generally, a good debt ratio is around 1 to 1.5. However, the ideal debt ratio will vary depending on the industry, as some industries use more debt financing than others. Capital-intensive industries like the financial and manufacturing industries often have higher ratios that can be greater than 2.
What is a good debt-equity ratio for banks? ›
What is a good debt-to-equity ratio? Although it varies from industry to industry, a debt-to-equity ratio of around 2 or 2.5 is generally considered good. This ratio tells us that for every dollar invested in the company, about 66 cents come from debt, while the other 33 cents come from the company's equity.
What is the ideal ratio for a bank? ›
Efficiency ratios at 50% or below are considered ideal. If an efficiency ratio starts to go up, then it indicates that a bank's expenses are increasing in comparison to its revenues or that its revenues are decreasing in comparison to its expenses.
What is the debt-to-equity ratio of JP Morgan? ›
JPMorgan Chase (JPMorgan Chase) Debt-to-Equity : 1.31 (As of Mar. 2024)
What is the debt-to-equity ratio for Wells Fargo? ›
Wells Fargo Debt to Equity Ratio: 1.162 for March 31, 2024
View and export this data back to 1990.
What is Goldman Sachs' debt to equity ratio? ›
The debt/equity ratio can be defined as a measure of a company's financial leverage calculated by dividing its long-term debt by stockholders' equity. Goldman Sachs BDC debt/equity for the three months ending December 31, 2023 was 1.14. Goldman Sachs BDC, Inc. is a specialty finance company.
What is the equity ratio in banking? ›
The equity ratio is a financial metric that measures the amount of leverage used by a company. It uses investments in assets and the amount of equity to determine how well a company manages its debts and funds its asset requirements.
What is the average bank industry ratio? ›
Well, the banking sector as a whole had a P/E ratio of approximately 13.50 and compares with an overall market average P/E ratio of 36.7.
What is a typical bank efficiency ratio? ›
The Efficiency Ratio for Banks Is:
Since a bank's operating expenses are in the numerator and its revenue is in the denominator, a lower efficiency ratio means that a bank is operating better. An efficiency ratio of 50% or under is considered optimal.
What are the 5 banking ratios? ›
5 Essential Financial Ratios for Every Business. The common financial ratios every business should track are 1) liquidity ratios 2) leverage ratios 3)efficiency ratio 4) profitability ratios and 5) market value ratios.
2. The maximum acceptable debt-to-equity ratio for more companies is between 1.5-2 or less. Large companies having a value higher than 2 of the debt-to-equity ratio is acceptable. 3.
Is a 40% debt to equity ratio good? ›
Most lenders hesitate to lend to someone with a debt to equity/asset ratio over 40%. Over 40% is considered a bad debt equity ratio for banks. Similarly, a good debt to asset ratio typically falls below 0.4 or 40%. This means that your total debt is less than 40% of your total assets.
Can debt to equity ratio be more than 100%? ›
A debt ratio of greater than 1.0 or 100% means a company has more debt than assets while a debt ratio of less than 100% indicates that a company has more assets than debt.
What is the average debt-to-equity ratio in industry? ›
Average Debt to Equity Ratio by Industry
| Industry | Average debt to equity ratio | Number of companies |
|---|
| Building Products & Equipment | 0.75 | 29 |
| Business Equipment & Supplies | 0.94 | 7 |
| Capital Markets | 0.57 | 33 |
| Chemicals | 0.87 | 17 |
124 more rowsThe lower value of the debt-to-equity ratio is considered favourable, as it indicates a reduced risk. So, if the ratio of debt to equity is 0.5, that means that the company has half its liabilities because it has equity.
Is a 40% debt-to-equity ratio good? ›
Most lenders hesitate to lend to someone with a debt to equity/asset ratio over 40%. Over 40% is considered a bad debt equity ratio for banks. Similarly, a good debt to asset ratio typically falls below 0.4 or 40%. This means that your total debt is less than 40% of your total assets.
Is 50% debt-to-equity ratio good? ›
Yes, a D/E ratio of 50% or 0.5 is very good. This means it is a low-debt business and the company's equity is twice as high as its debts.
Is a debt-to-equity ratio of 0.75 good? ›
A higher debt-to-equity ratio indicates that a company has higher debt, while a lower debt-to-equity ratio signals fewer debts. Generally, a good debt-to-equity ratio is less than 1.0, while a risky debt-to-equity ratio is greater than 2.0.
