Every business needs money to run and grow at an instant pace. That money comes from two places: the owners (equity) or outsiders such as banks and lenders (debt). The debt-to-equity ratio shows how these two sources are balanced. If you are an investor, a business owner, or a student, this one number can tell you a lot about how safe a company is.
In this blog we will understand the debt-to-equity ratio, its formula, how to calculate it, how to read the result, and why lenders care about it. We will care about it. And in a very simple way.
What is the debt-to-equity ratio
The debt-to-equity ratio is a financial ratio that tells us how much money a company has borrowed compared to the money invested by its owners or shareholders. In a very simple way we can compare debt as money the company has borrowed and needs to repay. And equity means money belonging to the owners or shareholders in a business. The more it borrows compared with its own funds, the higher its debt-to-equity ratio.
The ratio is called the D/E ratio. It is also known as total liabilities to shareholder’s equity, because that is exactly what it compares.
Debt-to-Equity ratio Formula
The debt-to-equity formula is:
Debt-to-equity ratio = Total liability / shareholders’ equity
Let us understand both parts:
Total liabilities: Everything the company owes. This includes bank loans, bonds, supplier dues, unpaid expenses and other obligations.
Shareholder’s equity: The owners’ share in the business. It is total assets minus total liabilities, and it includes share capital and retained profits.
How to calculate the debt-to-equity ratio
Here is a simple way to follow the debt-to-equity ratio calculation. This is how to calculate the debt-to-equity ratio in three steps:
Open the company’s balance sheet.
Find the total liabilities and the shareholder’s equity
Divide total liabilities by shareholder’s equity.
Debt-to-equity ratio Example
Here is a debt-to-equity example with easy numbers.
Suppose a company called Sunrise Traders has the following figures:
Item | Amount (Rs.) |
Total liabilities | 6,000,000 |
Shareholders' equity | 4,000,000 |
Debt-to-equity ratio = 6,000,000 / 4,000,000 = 1.5
This means sunrise traders use Rs. 1.50 of borrowed money for every Rs. 1 of the owner's money. The company depends more on outside funds than on its own.
How to interpret the debt-to-equity ratio
Knowing how to interpret the debt-to-equity ratio is just as important as calculating it. A number alone does not say much. Ask yourself these questions:
Is the ratio rising or falling over the years?
How does it compare with similar companies?
Is the company earning enough profit to pay its debt comfortably?
A rising ratio may mean the company is borrowing more and taking on more risk. A falling ratio may mean it is paying off debt or growing its own funds through profits.
What is a good debt-to-equity Ratio?
Many people ask, what is a good debt-to-equity ratio? There is no single perfect number, but a general guide helps:
Ratio | What it usually suggests |
Below 1 | The company relies more on its own funds. Generally seen as safer. |
Around 1 to 2 | Balanced mix of debt and equity. Acceptable for many businesses. |
Above 2 | Heavy dependence on debt. Needs a closer look. |
A ratio between 1 and 2 is often treated as comfortable, but the right level depends on the industry and the company’s earnings.
High Debt-to-Equity meaning
The high debt-to-equity ratio means that a company is funding its business mainly through borrowing. This can be risky because:
Interest and loan instalments must be paid even when sales are low.
The company may find it hard to get new loans
Shareholders may see lower profits after interest costs.
That said, a high ratio is not always bad. If the borrowed money is used to grow the business and earn good returns, it can work in the company’s favour.
Low debt-to-equity meaning
The low-to-debt ratio means that the company uses very little debt and depends mostly on owners’ funds. This usually shows:
The company depends less on loans to finance its business.
The company generally has less pressure to repay debt and interest.
The company uses more shareholders' funds than borrowed funds.
Ideal Debt-to-equity ratio by industry
The ideal debt-to-equity ratio by industry differs a lot, because some businesses need heavy investment in machines, land or infrastructure. The table below gives a rough idea. These are general guides and not fixed rules
Industry | Typical comfort level |
Banking and finance | Usually high, as borrowing is part of the business. |
Real estate and infrastructure | Often high, due to large project costs |
Manufacturing | Moderate, often around 1 to 2 |
IT and software services | Usually low, as they need less heavy equipment. |
Retail and FMCG | Low to moderate |
Debt-to-equity ratio advantages and limitations
The debt-to-equity ratio's advantages and limitations are worth knowing before you rely on it.
Advantages
It is simple and quick to calculate
It shows how much risk a company carries.
It helps compare companies in the same industry.
Limitations
Different people use different definitions of debt, so results can vary.
It does not show whether the company can actually pay its interest.
It ignores the quality of earnings and cash flow
It cannot be fairly compared across different industries.
Debt-to-equity ratio vs. debt ratio
The debt-to-equity ratio vs debt ratio difference is simple:
Debt ratio = Total liabilities / Total assets. It shows how much of the company’s assets are paid for by debt.
Debt-to-equity ratio = Total liabilities / Shareholders’ equity. It compares debt directly with the owners’ money.
Debt-to-equity ratio vs current ratio
In the debt-to-equity ratio vs. current ratio comparison, the key difference is time:
Current ratio: current assets / current liabilities. It checks whether the company can pay its short-term bills.
Debt-to-equity ratio: it checks the overall, long-term financial structure.
A company can have a healthy current ratio today but a risky D/E ratio in the long run, so both are useful.
Debt-to-equity ratio for loan eligibility
Banks and NBFCs look closely at the debt-to-equity ratio for loan eligibility, especially for business loans. Here is why it matters:
A lower ratio tells the lenders the business is not over-borrowed, so approval chances improve.
A very high ratio may lead to a smaller loan amount, a higher interest rate or even rejection.
Lenders often check it together with income, cash flow, credit history and repayment record.
So, if you are planning for a business loan, try to reduce unnecessary debt, clear existing dues and build up your retained profits before applying.
Tips to improve your Debt-to-Equity ratio
Pay off high-interest loans first
Avoid taking new debt unless it will earn a good return.
Keep profits in the business instead of withdrawing everything.
Bring in more owner capital if needed
Review your ratio every quarter or year.
FAQs
What is the debt-to-equity ratio in simple words?
It tells you how much a company has borrowed for every rupee of the owners’ money.
Can the debt-to-equity ratio be negative?
Yes, if a company’s liabilities Are more than its assets, equity becomes negative, and so does the ratio. This is a warning sign.
Is a lower debt-to-equity ratio always better?
Not always; 'lower' means less risk, but some debt can help a business grow.
Where do I find the number to calculate it?
You can find them on the company’s balance sheet in this annual report.