Comparison: Debt-to-Equity Ratio vs Debt Ratio
| Aspect | Debt-to-Equity Ratio (D/E) | Debt Ratio |
|---|---|---|
| Formula | Total Debt ÷ Shareholders’ Equity | Total Debt ÷ Total Assets |
| Main Focus | Debt compared with owners’ funds | Debt compared with total assets |
| What it measures | Capital structure and financial leverage | Overall solvency of the company |
| Perspective | Risk to shareholders | Risk to creditors and investors |
| High ratio means | Heavy reliance on debt financing | Large portion of assets financed by debt |
| Low ratio means | Conservative financing | Lower financial risk |
| Common users | Equity investors, management | Banks, lenders, analysts |
| Link to risk | High D/E increases shareholder risk | High debt ratio increases solvency risk |
Explanation
Debt-to-Equity Ratio
This ratio answers the question:
- “For every RM1 of shareholders’ funds, how much debt is used?”
- Focuses on who finances the company
- High D/E = higher financial leverage
- Can increase ROE, but also increases risk to shareholders
Debt Ratio
This ratio answers the question:
- “What percentage of the company’s assets is financed by debt?”
- Focuses on overall financial stability
- Debt ratio above 50% means more than half of assets are financed by debt
- Widely used by banks and creditors
Example
Company Information
- Total Debt = RM600,000
- Shareholders’ Equity = RM400,000
- Total Assets = RM1,000,000
Debt-to-Equity Ratio = 600,000÷400,000=1.5
Interpretation:
The company uses RM1.50 of debt for every RM1 of equity, indicating moderate to high leverage.
Debt Ratio = 600,000÷1,000,000=0.6 or 60%
Interpretation:
60% of the company’s assets are financed by debt, showing relatively high solvency risk.
Summary
- Debt-to-Equity Ratio → compares debt vs owners’ funds
- Debt Ratio → compares debt vs total assets
Always:
- State the formula
- Explain financial risk
- Compare with industry norms
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