How does a company pay for everything it does—like launching new products, opening branches, or hiring talent? Does it borrow money or rely on owner investment? The total debt-to-equity ratio answers that exact question.
This simple number shows how much a company leans on debt compared to owner investment.
But what does that actually tell you? Can it help you spot a strong business—or one that’s taking on too much risk?
What Is the Debt-to-Equity Ratio?
The debt-to-equity ratio shows how much a company is borrowing compared to how much money the owners have invested. It helps you understand if a business is relying more on loans or on its funds to run and grow.
It’s a simple formula that tells you:
“For every dollar of the owner’s money, how much debt does the company have?”
What Is Debt?
Debt is money a company borrows and must eventually pay back. This could be a bank loan, a bond, or even money borrowed from a credit line. Companies often use debt to:
- Buy new equipment
- Open new stores
- Hire more employees
- Develop products or services
Types of debt include:
- Short-term debt – Needs to be paid within a year (e.g., unpaid bills, short-term loans)
- Long-term debt – Paid over several years (e.g., bonds, mortgages, business loans)
To calculate total debt:
Add up all short-term and long-term liabilities from the balance sheet.
What Is Equity?
Equity is the value that belongs to the owners or shareholders after all debts are paid. It shows what part of the company the owners really “own.”
Equity includes:
- Common shares
- Preferred shares
- Retained earnings (profits the company kept instead of paying out)
- Extra money paid by investors above the share value
To calculate equity:
Equity = Total Assets – Total Liabilities
This is often found directly on the company’s balance sheet.
What Does the Debt-to-Equity Ratio Tell You?
The ratio gives a quick picture of how a company finances its operations:
- A low ratio means the company mostly uses its own money.
- A high ratio means the company is heavily borrowing.
This matters because:
- More debt means higher interest costs and more financial pressure.
- More equity usually means more stability, especially during tough times.
What Good Vs. Bad Debt Ratios
Not all debt to equity ratios are created equal—what’s considered “good” or “bad” can vary depending on the industry and business model. Knowing how to interpret the ratio helps you assess a company’s financial health and risk level more accurately.
A Good Ratio:
- Shows the company is borrowing wisely
- Helps the company grow without taking on too much risk
- Attracts investors and lenders by showing financial discipline
Good signs:
- Debt is used for smart investments (e.g., building a new facility or launching a new product)
- The company has a healthy balance between borrowing and owner money
- The company can easily pay its bills and loans
A Bad Ratio:
- Means the company is over-relying on debt
- Can lead to cash flow problems
- Might make it hard to get more loans or attract investors
Bad signs:
- Debt is used just to stay afloat, not grow
- The company struggles to repay debt
- Interest payments eat up profits
What Is a Negative Debt-to-Equity Ratio?
A negative debt-to-equity ratio happens when a company’s total liabilities are more than its total assets. In other words, the company has more debt than it owns.
This usually means:
- The company has lost money over time
- It may be facing financial trouble
- Lenders and investors might avoid giving it more money
A negative ratio is a red flag that shows the business may not be able to survive unless things improve.
How To Calculate the Ratio (Step-by-Step)
Understanding how to calculate the debt to equity ratio is essential for evaluating a company’s financial structure. Here’s a simple step-by-step guide to help you determine the ratio using data from the balance sheet.
1. Get Total Liabilities
From the balance sheet, add up:
- Short-term debts (bills, taxes, short-term loans)
- Long-term debts (bonds, long-term loans)
2. Get Shareholders’ Equity
This is also found on the balance sheet. If not listed, calculate it:
Equity = Total Assets – Total Liabilities
3. Use the Formula:
Debt-to-Equity Ratio = Total Liabilities / Shareholders’ Equity
Example
Suppose a company has:
- Total Liabilities = $300,000
- Total Assets = $500,000
Shareholders’ Equity = 500,000 – 300,000 = 200,000
Debt-to-Equity Ratio = 300,000 / 200,000 = 1.5
This means the company has $1.50 in debt for every $1 of equity.
When Should You Use This Ratio?
This ratio can help:
- Check Financial Health – Are they depending too much on loans?
- Compare With Others – How does the company stack up against competitors?
- Get a Loan or Investment – Lenders look at this before approving loans.
- Make Business Decisions – Helps owners decide if they should borrow more.
- Watch Trends Over Time – Shows if the company is improving or declining.
Why It’s Important for Businesses
- It shows financial balance – how much the company owes vs. owns
- It helps spot problems early, like rising debt levels
- It guides smart choices, like how to fund growth or reduce risk
Limitations of the Debt-to-Equity Ratio
This ratio is helpful, but it doesn’t show everything.
- Doesn’t show what kind of debt – Short-term vs. long-term matters.
- Doesn’t include interest rates – Some loans are more expensive than others.
- Ignores the timing of payments – Debt due soon is more stressful than long-term debt.
- Doesn’t include collateral – The assets backing the loan are important too.
What Can Affect the Ratio?
Several factors can influence a company’s debt to equity ratio, making it higher or lower over time. Changes in borrowing, retained earnings, or asset purchases can all shift the balance between debt and equity.
1. Size and Stage of the Business
- New businesses often rely more on debt.
- Older, profitable companies often have more equity.
2. Industry Differences
- Some industries borrow more by nature (like real estate and manufacturing).
- Others, like tech or consulting, might rely more on equity.
3. Economic Conditions
- In good times, companies may borrow more to grow.
- In bad times, they try to reduce debt and rely more on savings or equity.
Turn Numbers Into Insight—And Action
The total debt-to-equity ratio isn’t just a formula—it’s a powerful tool for understanding how a company manages its resources. Is it building a stable foundation or leaning too heavily on borrowed funds?
Now that you know how this ratio works, what it reveals, and why it matters, it’s time to apply it. Don’t just skim balance sheets—study them with purpose. Ask deeper questions. Compare across time and industries. Use this ratio to guide smarter choices, improve financial judgment, and sharpen your decision-making.
The numbers are in front of you. What will they tell you about your business—or the one you’re evaluating?
FAQs
What is the debt to equity ratio?
The debt to equity ratio is a financial metric that compares a company’s total liabilities to its shareholder equity. It shows how much debt a business is using to finance its operations relative to its own funds.
What is the formula for the debt to equity ratio?
The debt to equity ratio formula is:
Debt to Equity Ratio = Total Liabilities ÷ Shareholder’s Equity
This helps assess the financial leverage and risk level of a company.
How do you calculate the debt to equity ratio?
To calculate the debt to equity ratio, divide the company’s total liabilities by its total shareholder equity. You can find these figures on the company’s balance sheet under liabilities and equity sections.
What is a good debt to equity ratio?
A good debt to equity ratio varies by industry, but generally, a ratio between 1.0 and 2.0 is considered acceptable. A lower ratio indicates less risk, while a higher ratio may suggest higher financial leverage and potential vulnerability during downturns.