Debt-to-Equity Ratio: What Is It and How Is It Calculated?

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The debt-to-equity — or D/E — ratio tells a company how much debt it has compared to its shareholders’ equity or value in the company. This measure helps company leaders and interested parties determine the business’s financial health.

Why Is Measuring Debt to Equity Important?

Measuring debt to equity is not typically done in everyday accounting. It is a tool primarily used when an investor or lender is deciding whether to invest in or loan to a company.

For simplicity, you can consider your D/E ratio to act something like a credit report and debt-to-income ratio. When you apply for personal credit, lenders look at your current financial situation, including your regular debt, income and overdue debt. These numbers let the lender know whether or not they are likely to get their payments.

By calculating your company’s debt to equity, potential investors and lenders can see how much debt you have, how you use that debt and whether you’re a good investment. In short, it helps them see just how risky doing business with you could be.

How Do You Calculate the D/E Ratio?

The debt-to-equity ratio is calculated with this formula: D/E = Total Debt / Shareholders’ Equity.

Some examples of items that are calculated in the D/E ratio include:

• Lines of credit
• Notes payable
• Bonds payable
• The portion of long-term debt that’s due now

For a company that has $10,000 in liabilities and $7,500 in shareholders’ equity, the calculation would be as follows:

D/E = $10,000 / $7,500 = 1.33

What Is a Good Debt to Equity Ratio?

A business’s debt-to-equity ratio will change based on where the business is in its growth. It’s also different for every industry. For most businesses, the debt-to-equity ratio should not exceed 2.0. This means that the company owes twice as much in debt as it has in shareholder equity. Ideally, you want to keep it at 2.0 or lower.

What Are the Pros to a High Debt to Equity Ratio?

A high debt to equity ratio shows potential investors that the company is mainly funding itself by taking out loans. If the company is borrowing money responsibly and generating a lot of revenue, this can be a good thing.

What Are the Pros of a Low Debt to Equity Ratio?

A low debt to equity ratio shows potential investors that the company is funding itself through shareholder funding.

What’s good for your business really depends on what your goals are. 

Debt to Equity Ratio vs. Other Financial Ratios

Your debt to equity ratio is only one indicator of your business. Here are some other ratios to keep in mind:

Debt Ratio

Debt Ratio = Debts/Assets

To find this number, you need to total up all of the money you owe and divide it by everything you own that has value.

If your debt ratio is high, you owe more money than what you have. Depending on where your business is in its growth cycle, this could be bad.

Return on Equity

Return on Equity= Net Income/Shareholder Equity

This ratio shows how much the business is turning shareholder investments into profit.

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