Ask Colin

Could you explain the difference between the Debt to Equity Ratio and Leverage?

The debt to equity ratio is commonly calculated in two different ways. It is important always to know what the analyst whose work you are studying is using.

The most common way is

Debt to Equity = Debt divided by Equity

However, reasonably common is

Debt to Equity = Debt divided by Debt + Equity

If debt is $50m and Equity is $50m, the first method will give a debt to equity ration of 1.0 or 100%, while the second method will give a debt to equity ratio of 0.5, or 50%.

Leverage and Gearing are terms that describe the financial risk in a company. Thus a company with a high debt to equity ratio is said to be highly leveraged or highly geared.

Sometimes the second ratio method is called a gearing or leverage ration.

All of this is very confusing for the novie, but the professionals are making no discernable effort to clarify or standardise the terms. I guess it is how the high priests get to keep their control over the laity - only they can interpret the entrails.

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