So here we go with another ratio, the debt to equity ratio. The debt to equity ratio is going to help us analyze how a company's assets are financed. Debt to equity ratio is a common leverage ratio. Leverage ratios deal with the amount of debt that we have. Leverage is always talking about debt. A highly levered company has a lot of debt. Cool? So remember that our fundamental equation assets equal liabilities plus equity. Well, assets are everything the company owns, and then this is how they're financed: the liabilities and the equity. Liabilities are what we owe to others, and equity is what's owned by the company, by the shareholders of the company.

Now, you may have learned about the debt ratio as well, right? I don't want you to confuse the debt to equity ratio with the debt ratio. The debt ratio compares total liabilities to total assets, right? So our numerator is total liabilities divided by total assets in our denominator. total liabilitiestotal assets. So that's our debt ratio. Notice this ratio, debt to equity as we have in our box here. Well, we've got our total liabilities divided by total equity in this case. total liabilitiestotal equity.

So, how do we analyze this? Remember that every ratio is going to tell us how much of the numerator for each one of the denominator. So, how many dollars of debt for each dollar of equity that we have. You can imagine that a debt to equity ratio above 1.0, anything above 1, is going to imply that the company relies more on debt than equity. Because how are we going to get a number bigger than 1? Well, that's if the numerator is bigger than the denominator. So, liabilities would have to be more than equity. Now when is this a little more of a red flag is when they have a very high ratio. That means that the company is highly levered. They're highly levered, they have a lot of leverage because they're going to depend more on the loans than the equity financing. So this implies that they're risky. It's a riskier company because they have a lot of loans. And why does that make them risky? Well, when you have a lot of loans, that means you're going to have a lot of interest payments. And those interest payments aren't going to go away. When you finance with equity, well, you pay dividends to the shareholders, but you don't necessarily have to pay those dividends. You can hold off on dividends, but interest expense, you're going to have to pay it. So that adds this fixed expense that you're definitely going to have to cover. If you can't cover it, well, you're going to be in trouble. Cool? So a high ratio implies more risk. Cool? Alright. This is a pretty easy ratio. Why don't we just jump into some practice problems right away? Let's do it now.