How to Determine Target Debt to Equity
Debt to equity is one of the most popular measures of debt and credit risk. This is because, in terms of ownership, there are only two ways to finance a company: debt and equity. A company with more debt than equity must pay off this debt off, which represents a claim against the company's assets. A company financed more with equity is not required to pay back its investors; therefore, the company represents less risk to the company. The target debt to equity varies by industry and company objectives, but there are some common thresholds.
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Instructions
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Review the calculation for debt to equity. The formula for debt to equity is total liabilities divided by stockholders' equity. You can find both of these line items on the balance sheet that can be found in the company's annual report, which can usually be found on the company's website in Investor Relations.
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Walk through an example. Let's say you are a company with total liabilities of $100,000 and total equity of $200,000. The calculation is $100,000 / $200,000 = .5 or 50 percent.
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Interpret the results. A high debt-to-equity ratio means the company has been aggressive in growth through debt, whereas a low debt-to-equity ratio is indicative of a company that is aggressively financed through equity.
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Determine the target for your company, which depends on the industry. Capital-intensive industries have a need for more assets, which usually requires greater amounts of debt. It is not unusual for these companies to have a debt-to-equity ratio of above 2. Service-oriented companies, on the other hand, may have a debt-to-equity ratio of under .5.
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Look up the average debt to equity for your industry. Go to Yahoo! Finance. Yahoo! Finance is the top-rated investment research site according to Alexa.com, which rates companies based on popularity. See Resources for a link.
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Click on the Investing tab and then scroll down to Industry. Select the industry your company is in from the left-hand pane. On the right hand side, in the box labeled Industry Statistics, you will find the industry debt to equity.
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Tips & Warnings
Sometimes only interest-bearing, long-term debt is included in debt to equity.
