Data Driven Decisions: Debt-to-Equity Ratio

What is Debt-to-Equity (D/E) Ratio?

D/E ratio is an indicator of a company’s overall financial risk. Lenders are often interested in this ratio because it can provide an early signal when a company is taking on too much debt.

The formula is simple: total debt / total equity.

What does good look like?

The target D/E ratio varies by industry, but a lower ratio is generally better because it means the company has less reliance on debt. For example, a D/E ratio of 1.0 implies creditors and owners/shareholders have equal stake to the company’s assets. A ratio above 2.0-3.0 is typically unhealthy because the company is overly reliant on debt. However, a higher ratio could still be healthy depending on the industry and growth stage of the company. Industries that need to invest heavily in physical assets, like equipment and buildings, are expected to have a higher ratio.

Using debt-to-equity ratio as a business owner

Business owners can use D/E ratio to: 

• Understand their reliance on debt to determine if they should focus on reducing debt or if debt could be an option to fund growth

• Help creditors understand the company’s financial risk

When assessing D/E ratio, bear in mind that it is based on a point in time. It is prudent to look at the ratio over time before incorporating it into decisions. As with any ratio, it should not be used in isolation, but should be assessed in conjunction with other financial data.