Debt to equity ratio
From Wikicpa
The Debt to Equity ratio is a measure of a company's financial leverage calculated by dividing long-term debt by stockholder equity. It indicates what proportion of equity and debt the company is using to finance its assets.
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A high debt/equity ratio generally means a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense.
If a lot of debt is used to finance increased operations (high debt to equity), the company could potentially generate more earnings than it would have without this outside financing. If this were to increase earnings by a greater amount than the debt cost (interest), then the shareholders benefit as more earnings are being spread around to the same amount of shareholders. However, the cost of this debt financing may outweigh the return that the company generates on the debt through investment and business activities and become too much for the company to handle. This might lead to bankruptcy, which would leave shareholders with nothing, so it is a delicate balance. This is what the leverage effect is about and what the debt/equity ratio measures.
The debt/equity ratio will also be dependent on the industry in which the company operates. For example, capital-intensive industries such as auto manufacturing tend to have a debt/equity ratio above 2, while personal computer companies have a debt/equity of under 0.5.
