You hear about the debt-equity or debt-to-income ratio when making a budget or applying for a loan. But what exactly is it?
The debt-to-income ratio
The debt-to-income ratio compares your take-home payyour net monthly income after deducting taxes and pension plan contributionswith your debt. Creditors use this ratio to evaluate your ability to pay back a loan, that is, your creditworthiness.
How to calculate your debt-to-income ratio
To calculate your debt-to-income ratio, add up all your recurring monthly payments (rent or mortgage payments, home insurance, taxes, car payments, credit card payments, student loans, etc.) and divide the total by your net monthly income, including any monthly investment income you get.
When calculating your payments, don't include non-debt expenses, such as food or utilities (phone, electricity, transportation, etc.), though it can still be useful to know the total amount of these expenses because it can help you follow your budget.
What's a good debt-to-income ratio?
A debt-to-income ratio under 30% is excellent and a ratio of 30% to 35% is acceptable. A ratio higher than 40% could make creditors reject your application for an auto loan, student loan or mortgage. Plus, it's a sign you're in financial trouble!
The difference between your credit score and your debt-to-income ratio
Unlike your credit score, which shows your past credit behaviour, the debt-to-income ratio is a snapshot of your current financial status.
FAQs
The debt-to-equity (D/E) ratio is used to evaluate a company's financial leverage and is calculated by dividing a company's total liabilities by its shareholder equity.
What is a good ratio for debt to equity? ›
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.
How can I calculate my debt ratio? ›
How do I calculate my debt-to-income ratio? To calculate your DTI, you add up all your monthly debt payments and divide them by your gross monthly income. Your gross monthly income is generally the amount of money you have earned before your taxes and other deductions are taken out.
What is the formula for calculating debt ratio? ›
A company's debt ratio can be calculated by dividing total debt by total assets. A debt ratio of greater than 1.0 or 100% means a company has more debt than assets while a debt ratio of less than 100% indicates that a company has more assets than debt.
What is the debt-to-equity ratio for dummies? ›
The D/E ratio is a metric that can tell investors what proportion of a company's operations are funded with borrowed capital. The debt-to-equity ratio is calculated by dividing a company's total liabilities by its shareholders' equity.
Is 0.5 a good debt-to-equity ratio? ›
The lower value of the debt-to-equity ratio is considered favourable, as it indicates a reduced risk. So, if the ratio of debt to equity is 0.5, that means that the company has half its liabilities because it has equity.
What's a bad debt to equity ratio? ›
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.
What is the debt-to-equity ratio example? ›
Suppose a Company XYZ Ltd. has total liabilities of Rs 3,000 crore. It has shareholders equity of Rs 15,000 crore. Using the Debt to Equity Ratio formula, you get: Debt to Equity Ratio = 3,000 / 15,000 = 0.2.
What is a bad debt ratio? ›
The bad debt to sales ratio represents the fraction of uncollectible accounts receivables in a year compared to total sales. For example, if a company's revenue is $100,000 and it's unable to collect $3,000, the bad debt to sales ratio is (3,000/100,000=0.03).
Why do we calculate debt ratio? ›
Investors use the ratio to evaluate whether the company has enough funds to meet its current debt obligations and to assess whether it can pay a return on its investment. Creditors use the ratio to see how much debt the company already has and whether the company can repay its existing debts.
The key difference between debt ratio and debt to equity ratio is that while debt ratio measures the amount of debt as a proportion of assets, debt to equity ratio calculates how much debt a company has compared to the capital provided by shareholders.
Is 60/40 debt to equity good? ›
Broadly speaking, ratios of 60% (0.6) or more are considered high, while ratios of 40% (0.4) or less are considered low. However, what constitutes a “good debt ratio” can vary depending on industry norms, business objectives, and economic conditions.
How to calculate equity? ›
How Is Equity Calculated? Equity is equal to total assets minus its total liabilities. These figures can all be found on a company's balance sheet for a company.
What is the formula for debt-to-equity ratio for banks? ›
Calculating the D/E Ratio
The D/E ratio is calculated as total liabilities divided by total shareholders' equity. For example, if, as per the balance sheet, the total debt of a business is worth $60 million and the total equity is worth $130 million, then the debt-to-equity is 0.46.
What is the formula for debt-to-equity ratio in Excel? ›
To calculate this ratio in Excel, locate the total debt and total shareholder equity on the company's balance sheet. Input both figures into two adjacent cells, say B2 and B3. In cell B4, input the formula "=B2/B3" to obtain the D/E ratio.
