How is retained earnings used when calculating the debt-to-equity ratio?

Retained earnings are an essential component of total equity in a company's balance sheet. When calculating the debt-to-equity ratio, which is a measure of a company's financial leverage, retained earnings are included as part of shareholders' equity. This ratio is calculated by dividing total liabilities by total equity, where total equity encompasses common stock, additional paid-in capital, and retained earnings.

Including retained earnings signifies the accumulated profits that the company has retained for reinvestment rather than being distributed as dividends. Therefore, it contributes positively to the overall equity of the company, reinforcing the notion of equity as a buffer against debt. This inclusion provides a more comprehensive picture of the company’s financial health by reflecting the total resources available to shareholders, enhancing the reliability and accuracy of the debt-to-equity ratio.