How to Calculate Debt-to-Equity Ratio

The formula and where the numbers come from

Debt-to-equity = total liabilities / total shareholders' (owner's) equity. Both figures appear on the balance sheet.

Open your balance sheet at a specific date. The accounting equation says assets equal liabilities plus equity. Equity is what remains for owners after liabilities are subtracted from assets.

• Total liabilities: everything you owe, including accounts payable, credit cards, loans, accrued taxes and wages, and deferred revenue.
• Total equity: owner investment plus retained earnings, minus draws or dividends.

Debt-to-equity ratio = total liabilities / total equity.

Some analysts use only interest-bearing debt in the numerator, which gives a narrower measure. Pick a definition and stay consistent, and note which one a lender uses. Our assets, liabilities and equity guide explains each piece.

A worked example

With $240,000 in liabilities and $160,000 in equity, the ratio is 1.5. The business owes $1.50 for every $1.00 owners have invested.

This is an illustrative example with round numbers.

Check: assets of $400,000 equal liabilities of $240,000 plus equity of $160,000.

If $60,000 of that debt were paid off using cash, liabilities drop to $180,000 and so do assets, to $340,000. Equity stays $160,000, and the ratio improves to about 1.13. If instead the owners add $40,000 of capital, equity rises to $200,000 and the ratio falls to 1.2.

What counts as a good ratio

There is no universal target. Capital-heavy industries carry higher ratios than service firms. Compare against peers and your own history.

A ratio under 1.0 means owners fund more than creditors do. Above 1.0 means creditors fund more. Neither is automatically good or bad.

Industries with large equipment or inventory needs, such as manufacturing, construction and trucking, often run higher ratios. A consulting firm with few assets typically carries less debt. What matters is whether cash flow can comfortably service the debt.

Find industry benchmarks from trade associations or your accountant instead of relying on a single rule of thumb. Compare your ratio across quarters. A steady climb without matching growth in earnings is a warning sign.

How lenders use it

Lenders view a high ratio as higher risk because more of the business is funded by others. They pair it with cash flow measures such as debt service coverage.

Debt-to-equity shows how leveraged you are. A funder reading it asks: if revenue dips, is there enough cushion to keep paying? A higher ratio leaves less room.

Still, ratios are only one input. A business with a higher ratio but strong, steady deposits and a clear payback on new debt can be a better candidate than a business with low debt and flat revenue. Lenders also look at debt service coverage. See understanding debt service coverage ratio.

Banks and SBA lenders look at balance sheet ratios closely. Faster alternatives focus more on bank deposits and revenue consistency.

Common calculation mistakes

Mistakes include using book values that are out of date, mixing definitions, ignoring owner loans, and reading a negative equity figure as a normal ratio.

• Stale books. If your balance sheet is months behind, the ratio is unreliable. Reconcile accounts first. See bank reconciliation.
• Inconsistent definitions. Total liabilities and interest-bearing debt give different results.
• Owner loans. Money you lent the business is a liability on paper; lenders may treat it differently. Ask.
• Negative equity. If liabilities exceed assets, equity is negative and the ratio loses meaning. State it plainly instead.
• Ignoring off-balance-sheet items, such as operating leases or guarantees.

Ways to improve the ratio

Pay down high-cost debt, retain profits, add owner capital, and avoid borrowing for projects that do not produce a return.

You can improve the ratio from either side.

1. Reduce liabilities: pay off the highest-cost or shortest-term debt first.
2. Increase equity: keep earnings in the business instead of drawing everything out, or add owner capital.
3. Grow profit: higher net income raises retained earnings over time. See calculating net profit.
4. Manage working capital: collect receivables faster so you rely less on borrowing.

Be careful about trading one problem for another. Draining cash to pay debt can leave you short. Check your forecast first with cash flow forecasting.

Debt-to-equity and a decision to borrow

Before taking on more debt, check how it changes the ratio and whether the new revenue or savings will cover the payment comfortably.

Illustrative example: with $240,000 of liabilities and $160,000 of equity, adding $60,000 of new debt moves liabilities to $300,000 and the ratio to 1.875. If that $60,000 buys equipment that adds $6,000 of monthly gross profit against a $2,800 monthly payment, the extra debt pays for itself. If the equipment adds $2,000, it does not.

ROI Funder starts from what the money will produce, then shows true cost, payback period and monthly-equivalent payments before anyone signs. We consider 500+ FICO, 6+ months in business and $20,000+ monthly revenue. Applying is a few minutes with a soft credit pull. Compare structures in term loans and equipment financing.