How much of the business is borrowed
The debt-to-equity ratio compares what a company owes against what its owners have put in and left in. It is the standard measure of financial leverage, and the one that decides how much more a lender will advance.
The formula
Worked example: $200,000 of debt against $250,000 of equity
- Ratio: 0.80
- Read the other way: 44% of capital is borrowed, 56% is owned
Every dollar of equity carries 80 cents of debt. That is moderate for most trades and conservative for a few.
What the number means by sector
| Ratio | Typically |
|---|---|
| Below 0.5 | Software, services, businesses with few fixed assets |
| 0.5 – 1.5 | Manufacturing, retail, most trading businesses |
| 1.5 – 3.0 | Utilities, telecoms, capital-heavy with steady cash flow |
| Above 3.0 | Banks and insurers by design; anyone else under strain |
A bank at 10× is normal. A restaurant at 3× is one bad quarter from insolvency. The ratio only means something against the same sector.
Leverage cuts both ways
Borrowing at 6% to earn 12% on the assets raises the return on equity. Borrowing at 6% to earn 4% lowers it, and the interest is due regardless.
At 0.8, a 10% fall in asset value wipes out 18% of equity. At 3.0, the same fall removes 40%. The ratio is a measure of how much a bad year is amplified before it reaches the owners.
What counts as debt
Definitions vary, and the variation is large. Including only interest-bearing loans gives one figure; adding trade payables, lease obligations and deferred tax can double it. Ask which definition a covenant or a comparison uses before treating two ratios as comparable.
What this calculator leaves out
Whether the equity figure is real. Book equity can be inflated by goodwill from past acquisitions that no longer has value, and a ratio computed on tangible equity alone is often much higher.
What lenders do with it
Loan agreements commonly cap the ratio — 2.0 or 2.5 is typical for a trading business — and breaching the cap can make the facility repayable on demand. Every new loan raises the ratio before it generates any return, so the headroom under a covenant limits how fast a company can borrow to grow.
The ratio also sets the price. A business at 0.8 borrows at a lower margin than the same business at 2.0, because the lender's cushion is smaller.
Negative equity
A company that has lost more than its shareholders put in has negative equity, and the ratio becomes meaningless — dividing by a negative number produces a figure that looks fine and is not.
Aggressive buybacks can produce the same result in a healthy business, since repurchases reduce equity without touching debt. Read the ratio together with the balance sheet it came from.
Related calculators
- Debt-to-asset ratio — the same leverage as a share of total assets
- Interest coverage — whether earnings can service the debt
- Financial leverage ratio — how much the debt magnifies returns