What does a debt-to-equity ratio of 2.5 mean?
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.
The ratio is the number of times debt is to equity. Therefore, if a financial corporation's ratio is 2.5 it means that the debt outstanding is 2.5 times larger than their equity. Higher debt can result in volatile earnings due to additional interest expense as well as increased vulnerability to business downturns.
So, what is a good debt-to-equity ratio? 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.
The debt to equity ratio compares how much debt you have to how much equity you have. This should give you a number less than one. If it is more than one, you have more debt than assets or you have made an error.
Generally, a good debt to equity ratio is around 1 to 1.5. However, the ideal debt to equity ratio will vary depending on the industry, as some industries use more debt financing than others.
Poor debt-to-equity ratio
Using the debt-to-equity ratio, their calculation looks like this:Debt-to-equity ratio = $300,000 / $125,000Debt-to-equity ratio = 2.4The company's debt-to-equity ratio is 2.4, which means its debt is considerably higher than its assets, making it less likely for lenders to approve a loan.
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. A debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations.
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.
A D/E ratio of 2 indicates that the company derives two-thirds of its capital financing from debt and one-third from shareholder equity, so it borrows twice as much funding as it owns (2 debt units for every 1 equity unit).
A negative debt-to-equity ratio indicates that the company has more liabilities than assets. The company would be seen as extremely risky and or at risk of bankruptcy.
What is a bad debt to ratio?
Key takeaways
A good debt-to-income ratio is less than or equal to 36%. Any debt-to-income ratio above 43% is considered to be too much debt.
Still, as a general rule of thumb, most companies aim for an equity ratio of around 50%. Companies with ratios ranging around 50% to 80% tend to be considered “conservative”, while those with ratios between 20% and 40% are considered “leveraged”.
| Industry | Typical Debt to Equity Ratio Range |
|---|---|
| Financial Services (Banks) | 4.0 – 8.0 |
| Telecommunications | 1.0 – 2.5 |
| Industrial Manufacturing | 0.4 – 1.0 |
| Consumer Discretionary (Retail) | 0.5 – 1.5 |
With a debt to equity ratio of 1.2, investing is less risky for the lenders because the business is not highly leveraged — meaning it isn't primarily financed with debt.
D e b t t o E q u i t y r a t i o = T o t a l l i a b i l i t i e s T o t a l E q u i t y. A value of $1.75, therefore, indicates that for every dollar of equity, a firm uses $1.75 in debt to finance its assets. This ratio indicates that the business has more credit financing than the owner's financing.
Generally, a lower ratio is better, as it implies that the company is in less debt and is less risky for lenders and investors. A debt-to-equity ratio of 0.5 or below is considered good.
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.
A debt-to-equity ratio of 1.5 would indicate that the company in question has $1.50 of debt for every $1 of equity. To illustrate, suppose the company had assets of $2 million and liabilities of $1.2 million. Since equity is equal to assets minus liabilities, the company's equity would be $800,000.
Whether 1.25 is good largely depends on the industry in which the company operates. If you're in a capital intensive industry, then 1.25 may be considered a low debt to equity ratio. But if other companies don't have much debt, 1.25 might be high.
To lower your company's debt-to-equity ratio, you can pay down loans, increase profitability, improve inventory management and restructure debt.
How do you interpret the debt ratio?
Interpreting the Debt Ratio
If the ratio is over 1, a company has more debt than assets. If the ratio is below 1, the company has more assets than debt. Broadly speaking, ratios of 60% (0.6) or more are considered high, while ratios of 40% (0.4) or less are considered low.
Generally speaking, a good quick ratio is anything above 1 or 1:1. A ratio of 1:1 would mean the company has the same amount of liquid assets as current liabilities. A higher ratio indicates the company could pay off current liabilities several times over.
Your debt-to-income (DTI) ratio is how much money you earn versus what you spend. It's calculated by dividing your monthly debts by your gross monthly income. Generally, it's a good idea to keep your DTI ratio below 43%, though 35% or less is considered “good.”
The debt to equity ratio shows a company's debt as a percentage of its shareholder's equity. If the debt to equity ratio is less than 1.0, then the firm is generally less risky than firms whose debt to equity ratio is greater than 1.0.
Having said that, most experts believe a D/E ratio between 1.5 to 2.5 shows the company is financially stable. Taking the above examples, a D/E ratio of 0.25 is very good as it shows that the company is mostly funded by equity assets and has low obligations to repay.
