The ratio of a company's equity, or the total ownership interest in the company, and its debt is a commonly used metric to evaluate the ability of a company to survive unexpected economic shocks. Analysts sometimes divide a company's debt into short-term and long-term categories. Short-term, or current, liabilities are due within one year. Liabilities due more than one year out are long-term debts.
Obtain the annual report or the most recent company financials available. Publicly traded companies must file this information annually with the Securities Exchange Commission (SEC). It may also be available in the company prospectus. If the company is not publicly traded, you may need to have the company management provide you with the information.
Locate the balance sheet in the annual report or financial statement. If it is not labeled "balance sheet" look for two columns, entitled "assets" and "liabilities." Assets are things that the company owns as of the date of the annual report. Liabilities is money owed. The difference between these two numbers is the company net worth, or book value.
Find an entry in the assets column called "shareholders' equity," "total equity" or something similar.
Find an entry in the liabilities column called "long-term debt" or "long-term liabilities." If the report does not spell out the liabilities, though, you may need to add up all liabilities with due dates within the year, which you can identify by reading the itemized list of liabilities in the financial statement. Take the sum of all the liabilities you can identify as short-term and subtract that figure from the long term liabilities.
Divide the figure you arrived at in Step 4 by the total shareholders' equity. The resulting ratio is the long-term debt to equity ratio.
The ratio itself tells you little except in relation to other companies in the same industry. The higher the debt to equity ratio of a company relative to its peers, the more leveraged the company is. Leveraged companies tend to outperform in bull markets, but are risky in bear markets.
- "Security Analysis"; Benjamin Graham and Thomas Dodd; 1934