Joshua earned an MBA from USF and writes mostly about software and technology.
Understanding the capability of a company to raise capital is key to understanding their financial position. The debt to equity ratio gives insight into this. For instance, the debt to equity ratio can let a business know the right time to leverage debt or when to change policies related to stock issuance.
What Is the Debt-to-Equity Ratio?
The debt to equity ratio (debt-equity ratio) can be described as the amount of debt a company has per dollar of equity. The data needed to calculate this ratio can be abstracted from the balance sheet of a company and It is calculated as:
Debt to Equity Ratio = Total Debt / Total Equity
Don't get the debt to equity ratio confused with the long-term debt to equity ratio which is used only to analyze debt that is not expected to be paid within a year.
Debt to Equity Ratio Outcome
This ratio measures the amount of risk associated with a company’s capital structure. When the debt to equity ratio is very high (say above 2) there may not be any room for a company to borrow more money. The more debt that is issued (short-term and long-term), the more risky doing business is because of the added interest expenses. Alternatively, issuing new stock instead of issuing new debt would drive risk down.
The illustration below provides general guidelines for what different results may mean. Understanding what a good result is may depend on what industry the company being measured is in. One needs to decide whether to fall in line with benchmarks created by an average from that industry.
Debt-to-Equity Ratio Example
For example, let us take a look at the debt to equity ratio of Amazon Inc. Amazon’s total debt and total equity for the fiscal year 2019 is $163,188,000,000 and $62,060,000,000 respectfully. These figures can be found by reviewing the balance sheet illustration below. Note that total debt was found by subtracting the total equity from the total equity and debt total. Amazon's debt to equity ratio for 2019 is:
163,188,000,000 / 62,060,000,000 = 2.630
Partial Amazon Balance Sheet From Fiscal Year 2019
Debt-to-Equity Ratio Analysis
Amazon's debt-equity ratio history can give you an idea of how the debt-equity ratio may be in the future. It looks like Amazon had a higher debt to equity ratio in 2017 due to rising debt obligations. This was followed by a drop in debt to equity each year.
Amazon Debt-to-Equity Ratio History
To drill down a little deeper, see the percentages change in total debt and total equity below. Analyzing this shows you proportionately why the ratio changed.
Amazon's Percent Changes in Debt and Equity For 2017–2019
|Fiscal Year||Total Debt||Total Equity||D to E Ratio|
Below is also a line graph giving a pictorial view of Amazon's historical debt to equity ratio. You may guess that the debt to equity ratio is going down. To make a clear prediction of the future annual ratios news about Amazon and quarterly financial statements would need to be followed to understand how Amazon may raise capital for future projects.
Amazon Debt-to-Equity Line Graph
Debt-to-Equity Ratio Comparisons
To make a judgment on whether the debt-equity ratio is too high or low for an industry a company can compare its ratio to its competitors. Below, Amazon's debt to equity ratio matched up against other e-commerce giants such as Walmart and eBay.
It appears that Amazon doesn't leverage nearly as much debt as eBay which suggests that Amazon is in a healthier financial position. Walmart has a lower debt to equity ratio so we know that they are adding more capital to the business through stock issuance.
Another type of benchmarking can be conducted by comparing it to an industry average. For instance, the miscellaneous retail average for the debt to equity ratio was 1.52 reported by readyratios.com. Amazon may use this metric as a reason to decrease debt to align itself with the industry. Although, being the leader in e-commerce in this age, perhaps companies should be looking at Amazon's model.
This content is accurate and true to the best of the author’s knowledge and is not meant to substitute for formal and individualized advice from a qualified professional.
© 2020 Joshua Crowder