Debt-to-equity ratio: formula, calculation and what it means

Published Saturday 8 August 2026

Table of contents

• What is the debt-to-equity ratio?
• Debt-to-equity ratio formula
• How to calculate the debt-to-equity ratio
• What is a good debt-to-equity ratio?
• Debt-to-equity ratio by industry
• How to improve your debt-to-equity ratio
• Limitations of the debt-to-equity ratio
• Simplify your financial management with Xero
• FAQs on the debt-to-equity ratio

Key takeaways

• The debt-to-equity (D/E) ratio compares your total liabilities to total equity, showing how much of your business is funded by debt versus owner investment.
• You can calculate your D/E ratio using a simple formula: total liabilities divided by total equity. Both figures come directly from your balance sheet.
• A high ratio may signal too much reliance on borrowed funds, while a very low ratio could mean you're not taking advantage of financing options that support growth. A ratio between 1.0 and 2.0 is generally considered acceptable for most small and mid-sized businesses.
• The D/E ratio is just one measure of financial health. Pair it with cash flow analysis, the interest coverage ratio, and industry benchmarks to get the full picture.

What is the debt-to-equity ratio?

The debt-to-equity (D/E) ratio is a financial metric that measures the proportion of a company's total liabilities to its total shareholders' equity, indicating how much debt a business uses to finance its operations relative to the value owned by its shareholders. In simple terms, it tells you how much of your business is funded by borrowing compared to how much is funded by you and any other owners.

Think of it this way: if your business has $500,000 in total debt and $500,000 in equity, your D/E ratio is 1.0. That means for every dollar of owner investment, there's one dollar of debt. But if you have $1 million in debt and $500,000 in owner equity, your ratio is 2.0, meaning you owe one dollar for every two dollars of owner investment. The higher the number, the more your business relies on borrowed money.

Lenders, investors, and business owners rely on this metric to assess a company's financial structure at a glance.

Why the debt-to-equity ratio matters for your business

Your D/E ratio gives you a clear snapshot of how your business is financed – by loans or owner investments. It helps you understand whether you're carrying a comfortable level of debt or stretching your borrowing too far.

Lenders and investors look at this number when deciding whether to extend credit or invest in your business. A ratio that's too high could make it harder to secure a loan or attract funding. On the other hand, a ratio that's too low might suggest you're not using available financing to grow.

Tracking your D/E ratio over time also helps you spot trends. If the ratio keeps climbing, it may be time to rethink your financial strategy before debt becomes difficult to manage.

The Small Business Administration has resources on how to access funding and use debt in your business.

Debt-to-equity ratio formula

The debt-to-equity ratio formula is straightforward. You only need two numbers from your balance sheet to calculate it.

D/E ratio = Total liabilities / Total equity

Total liabilities include everything your business owes. Total equity represents the value that belongs to the owners after all debts are paid. Dividing one by the other gives you a single number that summarizes your financial structure.

What counts as debt?

Your total liabilities include all financial obligations your business currently holds. Here are common examples:

• Short-term loans and lines of credit
• Long-term bank loans and mortgages
• Accounts payable (money owed to suppliers)
• Credit card balances
• Accrued expenses such as wages, taxes, and utilities
• Lease obligations
• Deferred revenue (payments received for goods or services not yet delivered)

What counts as equity

Total equity represents the owners' stake in the business – it's liabilities subtracted from assets, but it appears on the balance sheet, so you don't need to calculate anything. It typically includes:

• Owner's capital contributions (money invested into the business)
• Retained earnings (profits reinvested rather than distributed)
• Additional paid-in capital from investors
• Treasury stock adjustments (if applicable)

The US Chamber of Commerce has more on what business equity means.

How to calculate the debt-to-equity ratio

Follow these four steps to calculate your D/E ratio using information from your accounting records.

1. Pull up your balance sheet. You'll find total liabilities and total equity listed as separate line items. If you use accounting software, your balance sheet is typically available in your reports section.
2. Identify your total liabilities. Your balance sheet should show a total liabilities. If not, add up your current liabilities (due within one year) and long-term liabilities (due after one year).
3. Find your total equity. The report will list a total, which includes owner contributions, retained earnings, and any other equity accounts listed on your balance sheet.
4. Divide total liabilities by total equity. The result is your D/E ratio. Express it as a decimal, for example, 1.5, rather than a percentage. If your equity is higher than your liabilities, it'll be less than one – for example, 0.75 if your liabilities are $75,000 and your equity is $100,000.

Calculation example

Here are two worked examples using realistic numbers for a small to mid-sized business.

Example 1: A professional services firm

Total liabilities: $420,000 (including a $300,000 business loan, $80,000 in accounts payable, and $40,000 in accrued expenses)

Total equity: $580,000 (including $200,000 in owner contributions and $380,000 in retained earnings)

D/E ratio = $420,000 / $580,000 = 0.72

Example 2: A retail business

Total liabilities: $1,100,000 (including a $700,000 commercial mortgage, $250,000 in inventory financing, and $150,000 in accounts payable)

Total equity: $900,000 (including $400,000 in owner capital and $500,000 in retained earnings)

D/E ratio = $1,100,000 / $900,000 = 1.22

What the result means

Once you've calculated your ratio, here's how to interpret the number:

• Below 1.0: Your business has more equity than debt. This suggests a conservative financial structure with lower risk, though it could also mean you're not fully using debt to fund growth opportunities.
• Equal to 1.0: Debt and equity are balanced equally. For every dollar of equity, there's one dollar of debt. This is often seen as a neutral position.
• Above 1.0: Your business carries more debt than equity. This isn't automatically a problem, especially if the borrowed funds generate strong returns, but it does increase financial risk if revenue dips.

What is a good debt-to-equity ratio?

For most small and mid-sized businesses, a D/E ratio between 1.0 and 2.0 is generally considered acceptable. However, what counts as "good" depends on your industry, growth stage, and how comfortably your cash flow covers your debt payments.

A business in a capital-intensive industry like manufacturing or utilities might operate comfortably at 1.5, while a professional services firm with few physical assets might aim for something well below 1.0.

High debt-to-equity ratio

A high D/E ratio, typically above 2.0, means your business relies heavily on borrowed funds. This can make sense if you're financing equipment, inventory, or expansion that will generate returns greater than the cost of borrowing.

The risk is that high debt increases your fixed obligations. If revenue slows down, you still need to make those loan payments. Lenders may also view a high ratio as a sign of financial strain, which could limit your ability to borrow more when you need it.

Low debt-to-equity ratio

A low D/E ratio, generally below 0.5, indicates that your business is mostly funded by owner equity. This means less financial risk and fewer obligations to lenders.

On the other hand, a very low ratio could suggest you're passing up growth opportunities. Sensible borrowing can help you invest in new equipment, hire staff, or expand into new markets faster than relying on profits alone.

Negative debt-to-equity ratio

A negative D/E ratio occurs when total equity drops below zero. This happens when accumulated losses exceed the total capital invested by owners, resulting in negative shareholders' equity. It can also happen if your business's debts exceed the value of its assets – for example, if you funded a business with a $100,000 loan, have $50,000 in equipment, but contributed nothing in owner capital, that will create $50,000 of negative equity..

A negative ratio is a serious warning sign. It means liabilities exceed assets, and the business may be technically insolvent. This can happen with start-ups in some situations, but if you unexpectedly find yourself in this position, speak with a financial advisor or accountant to explore options for restructuring.

Debt-to-equity ratio by industry

D/E ratios vary widely across industries because each sector has different capital needs and business models. Here are typical ranges to use as benchmarks:

• Technology: 0.2 to 0.6. Tech companies tend to carry less debt than equity because they have fewer physical assets and often fund growth through equity or cash reserves.
• Professional services: Below 0.5. Service-based businesses typically need minimal capital investment, so they often carry less debt relative to equity.
• Retail: 0.5 to 1.3. Retailers often borrow to finance inventory and store operations, and carry significant accounts payable, typically pushing ratios higher than service-based businesses.
• Manufacturing: 0.3 to 1.5. Manufacturers need significant investment in equipment and facilities, which often requires financing. Ratios vary based on the scale of operations.
• Utilities: 0.9 to 1.6. Utilities require large infrastructure investments and carry steady, predictable revenue, allowing them to support higher debt levels.

How to improve your debt-to-equity ratio

If your D/E ratio is higher than you'd like, there are several practical strategies you can use to bring it down over time.

• Pay down existing debt: Focus on repaying high-interest loans first. Even small additional payments toward principal balances can reduce your total liabilities and improve your ratio over time.
• Increase retained earnings: Reinvest profits back into the business rather than distributing them. This builds equity and naturally improves the ratio.
• Reduce unnecessary expenses: Review your operating costs and cut spending that isn't contributing to revenue. The savings can go toward paying off debt faster or boosting equity by increasing retained earnings.
• Avoid taking on new debt: Before borrowing, consider whether the expense can be funded through existing cash flow or revenue. Each new loan increases your liabilities and pushes the ratio higher.
• Bring in additional equity: If you're open to it, a business partner (who’s got capital or assets to contribute) or an investor can add equity to your balance sheet without increasing debt.
• Restructure existing debt: Refinancing high-interest loans at lower rates reduces your total interest obligations, making it easier to pay down debts faster. Consolidating multiple loans into one can also simplify payments and lower your overall liability balance over time

Limitations of the debt-to-equity ratio

While the D/E ratio is a useful starting point, it doesn't tell the whole story about your business's financial health. Keep these limitations in mind.

The ratio treats all debt equally. A low-interest, long-term loan is very different from a high-interest credit card balance, but both contribute to total liabilities in the same way. The D/E ratio doesn't distinguish between the two.

It uses book values rather than market values for assets. The equity figure on your balance sheet reflects the historical costs of your assets, not what your business is actually worth today. This can make the ratio less accurate for businesses with significant intangible assets or appreciated property.

The ratio is a snapshot in time. Your D/E ratio on one particular date might not reflect how it looks a month or a year later, especially if your business has seasonal fluctuations in revenue or spending.

It doesn't account for cash flow. A business with a high D/E ratio but strong, consistent cash flow may be in a much better position than one with a low ratio but tight cash reserves. The ability to service debt matters as much as the amount of debt you carry.

For a more complete view of financial health, pair the D/E ratio with other metrics such as the current ratio, interest coverage ratio, and cash flow statements.

Simplify your financial management with Xero

Tracking ratios like the D/E ratio starts with having accurate, up-to-date financial data. Xero's online accounting software gives you real-time access to your balance sheet, profit and loss statements, and cash flow reports, so you can monitor your financial position and make confident decisions.

With automated bank feeds, invoicing, and expense tracking, you spend less time on manual bookkeeping and more time running your business. And when it's time to share your numbers with a lender or accountant, your reports are ready to go.

Try Xero and get started today.

FAQs on the debt-to-equity ratio

Here are answers to some commonly asked questions about the debt-to-equity ratio.

What is the difference between debt ratio and debt-to-equity ratio?

The debt ratio divides total liabilities by total assets, giving you the percentage of assets funded by debt. The D/E ratio divides total liabilities by total equity, showing how debt compares specifically to owner investment. Both measure financial risk, but they use different denominators.

Can the debt-to-equity ratio be negative?

Yes. A negative D/E ratio means your business has negative equity, which happens when accumulated losses exceed total owner investment. This typically signals financial distress and may require restructuring or additional capital.

How often should you check your debt-to-equity ratio?

Review your D/E ratio at least quarterly, or more often if your business is growing rapidly or taking on new debt. Regular monitoring helps you spot trends early and adjust your financial strategy before small shifts become bigger concerns.

Does the debt-to-equity ratio affect your ability to get a loan?

Yes, lenders commonly review the D/E ratio as part of their assessment. A ratio above 2.0 may raise concerns about your ability to repay, potentially leading to higher interest rates or a declined application. Keeping your ratio within industry norms strengthens your borrowing position.