The debt-to-equity ratio measures the amount of debts a company uses to finance its capital and indicates how financially leveraged a company is. This ratio is calculated by dividing a company’s total liabilities by its total equity.
For example, company A has a total equity of $200,000, and its liabilities total to $40,000. The company’s debt-to-equity ratio is $40,000 divided by $200,000, or 20 percent. Company B also has a total equity of $200,000, but it liabilities total to $500,000. Company B’s debt-to-equity ratio is $500,000 divided by $200,000, or 250 percent. Compared to company A, company B relies more heavily on debt to finance its capital and is a riskier investment for investors.