As of the third quarter of 2024, U.S. nonfinancial corporations held a total debt-to-equity ratio of approximately 84.5%, reflecting a notable reliance on external funding compared to shareholder equity.
Companies with rising debt-to-equity ratios raise questions about their funding strategy and the types of loans they choose.
Are they betting on future returns or stretching their balance sheets?
When the debt-to-equity ratio increases, it generally signifies the need for a thorough financial review to avoid potential debt traps.
However, beyond funding, how relevant is the debt-to-equity ratio to your overall business outlook, especially in scenarios approaching bankruptcy?
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What Is the Debt-to-Equity Ratio?
The debt-to-equity ratio (D/E) is a leverage and solvency ratio that compares a company’s total liabilities against its shareholder equity.
It measures how much a business relies on borrowed capital instead of funding its operations through investors.
The entity of the business, whether it’s a corporation, partnership, or LLC, affects how equity is raised and how debts are reported.
Financial analysts, lenders, potential investors, and stakeholders use this ratio to evaluate risk levels tied to a company’s capital structure.
This ratio also falls under the category of gearing ratios, which measure companies’ overall debt against their value and inform a debt management plan.
Key Concepts of the Debt-to-Equity Ratio
The debt-to-equity ratio connects two core balance sheet elements: total debt and shareholder equity.
Debt
Debt refers to the money borrowed by a company, typically through loans, credit facilities, or bond issuance.
Most corporate debt obligations come with specific repayment terms and interest costs.
Depending on the structure, repayment may follow a fixed schedule or a lump sum due at maturity.
Companies operating in capital-intensive sectors also structure their financing to match the lifecycle of their significant assets.
Equity
Equity reflects a company’s ownership value after paying all liabilities. It includes common stock, preferred shares, retained earnings, and additional paid-in capital.
If a company were to liquidate, equity is what shareholders would receive after settling all debts. This also impacts how lenders view your business loan approval potential during credit assessments.
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What Does the Debt-to-Equity Ratio Tell You?
The debt-to-equity ratio indicates how much of a company’s capital comes from debt versus its own funding.
Debt carries repayment obligations and interest expenses that reduce earnings and cash flow.
If not managed, high debt levels can significantly impact equity, especially when earnings decline or interest rates rise. In extreme cases, they can increase the risk of insolvency.
What Debts Are Included in the Debt-to-Equity Ratio?
Below are the liabilities included in a debt-to-equity ratio analysis:
Short-Term Liabilities
Short-term liabilities refer to financing obligations due within one year. They include short-term loans, lines of credit, and other borrowed funds used for working capital.
These debts can temporarily increase leverage and directly affect the company’s ability to meet short-term financial targets.
Long-Term Liabilities
Long-term liabilities cover obligations that extend beyond twelve months. These include long-term bank loans, bonds, and multi-year lease commitments.
Since these debts influence a company’s long-term capital structure, they are consistently included in debt-to-equity evaluations.
Their size and terms generally carry more weight in assessing solvency risk and future borrowing limits.
Accrued Liabilities
Accrued liabilities are unpaid incurred expenses. They typically include accrued interest, wages, and taxes.
These debts are usually included in debt-to-equity analyses when directly related to financing costs, such as unpaid interest on loans.
Accounts Payable
Accounts payable are short-term obligations arising from operational purchases like inventory or services.
These are not financing activities and are usually excluded from debt calculations. However, in specific analytical contexts where broader leverage is reviewed, they may be included.
Mortgages Payable
Mortgages payable are long-term loans secured by property. These are counted as part of the total debt since they represent formal lending agreements with defined repayment structures.
They also signify investment in fixed assets, which adds context to a company’s financial commitments and asset base.
Bonds Payable
Bonds payable represent long-term debt raised through public or private bond issuance.
These are included because they reflect capital raised through financing markets and must be repaid according to fixed schedules.
Interest on bonds also affects cash flow, making them a critical component of debt calculations.
Deferred Tax Liabilities
Deferred tax liabilities stem from timing differences between financial reporting and tax recognition.
While not traditional debt, they are included in some debt-to-equity ratio calculations, especially if the amounts are material.
They reflect future cash outflows and affect long-term business financial planning.
Leases and Other Financing Arrangements on the Company’s Balance Sheet
Lease obligations under standards such as IFRS 16 or ASC 842 are treated as debt. These include capital leases and other financing agreements that involve fixed payments.
Since they function like loans, they are recognized as liabilities that affect leverage and repayment capacity.
Contingent Liabilities (Guarantees or Litigation)
Contingent liabilities include potential obligations that depend on future events, such as legal disputes or guarantees.
These debts are not recorded unless the outcome is both probable and measurable.
Although they’re generally excluded from the formal debt-to-equity ratio, analysts consider them in qualitative risk assessments when evaluating financial exposure.
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How to Calculate the Debt-to-Equity Ratio
To calculate the debt-to-equity ratio, divide total liabilities by total shareholders’ equity. Both figures come from the company’s balance sheet.
Where:
D/E = Total Liabilities ÷ Total Shareholders’ Equity
Although the formula is simple, the components may include items that affect interpretation.
Shareholder equity, for example, can be influenced by retained earnings, losses, and non-cash adjustments like pension liabilities or goodwill write-offs.
These entries don’t represent cash or tangible assets but still affect the final value, sometimes distorting the ratio.
Investors often adjust the calculation to improve comparisons or to isolate specific risk factors. They might also assess it alongside short-term leverage ratios and metrics tied to profitability or forecasted growth.
Additionally, business owners commonly use software such as Microsoft Excel for tracking.
Excel templates can automatically apply an equity ratio calculator using built-in balance sheet layouts. This option is ideal for small businesses, particularly for sole proprietors.
For manual entry, place total liabilities in one cell (B2) and shareholder equity in another (B3). Then, apply the formula “=B2/B3” in a third cell to get the result.
Example:
Suppose a company reports $3.5 million in total liabilities and $2.5 million in shareholders’ equity. The debt-to-equity ratio would be:
D/E: $3,500,000 ÷ $2,500,000 = 1.4
This result means the company uses $1.40 in debt for every $1.00 of equity. It reflects a higher dependence on borrowed funds compared to internally funded capital.
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What Is a Good Debt-to-Equity Ratio?
What qualifies as a good debt-to-equity ratio depends on the sector and the company’s capital structure.
In general, a ratio under one signals that equity outweighs debt, which often reflects lower financial risk.
Meanwhile, a ratio above two may suggest higher leverage, which increases exposure to interest obligations and credit risks.
Some industries operate with higher debt financing by design. Utilities, banking, and consumer staples tend to carry more long-term debt because of stable revenue and capital requirements.
On the other hand, low ratios may imply that a company avoids financing growth through debt.
This could suggest a conservative strategy or missed opportunities to reduce tax exposure through interest deductions.
What Does a Negative Debt-to-Equity Ratio Signal?
A negative debt-to-equity ratio or a higher ratio suggests total liabilities exceed total assets, resulting in negative shareholder equity.
This usually means poor financial health, especially if accompanied by declining revenue or cash flow. In these cases, the company may be at risk of default or even bankruptcy.
Some industries tolerate higher D/E ratios, such as banks, which rely on customer deposits and operate with extensive fixed assets.
Capital-heavy sectors like airlines and manufacturing also tend to use more debt.
Newer companies, especially those pursuing startup business loans, may show higher D/E ratios as they scale quickly.
But even in these fields, consistently rising D/E values can lead to strained credit access and reduced flexibility.
Over time, an inability to service existing loans could lead to default or forced restructuring.
What Does a 1.5 Debt-to-Equity Ratio Mean?
A debt-to-equity ratio of 1.5 shows that a company has $1.50 of debt for every $1.00 of equity.
For example, if a company has total assets worth $2 million and liabilities of $1.2 million, then equity equals $800,000. Dividing $1.2 million by $800,000 gives a ratio of 1.5.
This result means debt makes up a larger share of the capital base than equity, which, depending on the context, could indicate higher risk or an aggressive growth strategy.
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Why Is the Debt-to-Equity Ratio Important?
The debt-to-equity ratio provides context to a company’s financial structure in the following ways:
Helps Assess Your Company’s Financial Health and Stability
The D/E ratio shows whether the company depends more on debt or equity for funding. It allows stakeholders to gauge how the business might respond to financial stress or market shifts.
As such, a stable capital structure suggests the company can absorb shocks without triggering liquidity issues.
Provides a Metric for Risk Assessment
The D/E ratio serves as a risk gauge for lenders and equity investors.
A high figure suggests elevated financial risk, as more of the company’s resources are obligated to debt repayment.
Moreover, creditors use this to evaluate the probability of repayment. Higher debt levels can also lead to higher borrowing costs and stricter lending terms.
Indicates Your Ability to Meet Financial Obligations to Lenders and Investors
Consistently good D/E metric demonstrates that a company can manage its loan schedules and interest costs. This helps build trust with current lenders and makes future borrowing easier.
If the ratio climbs too high, it may lead to lower credit ratings or tighter loan agreements.
Influences Decision About Borrowing, Expansion, and Investment
Companies assess the debt-to-equity ratio before making large funding amounts. If the current structure leans heavily on debt, they might hold off on new loans or seek equity funding.
The ratio also affects asset purchases or funding mergers, where leverage influences both deal terms and future return expectations.
Helps Compare Your Debts to Industry Benchmarks
The D/E ratio helps analysts measure how a company’s financing compares to competitors.
Capital structures differ across sectors, so checking this metric against industry averages shows whether a business carries more or less debt than expected.
It also points out companies that take on too much debt or use too little, based on sector norms.
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What Are the Limitations of the Debt-to-Equity Ratio?
The debt-to-equity ratio carries the following blind spots that can affect its overall results:
May Overestimate Debt
The D/E calculation counts all liabilities equally, including those with short-term impact.
For example, some short-term payables might be routine and low-risk, yet they still inflate the debt figure. This can make the company seem more leveraged than it actually is.
Ignores Debt Quality
Since the D/E ratio treats all forms of debt the same, a business carrying low-interest, secured debt looks the same as one holding high-interest or risky loans.
As a result, the ratio doesn’t reflect the cost of debt or its specific terms, such as covenants or maturity schedules.
Doesn’t Reflect Cash Flow and Profitability
A company may carry substantial debt but also generate strong cash flow and profits.
Because the calculation ignores how well the business performs operationally, a company might appear risky based on the ratio alone, even if it easily covers its obligations.
Debt-to-Equity Ratio Varies by Industry
Different sectors operate with varying norms of capital. What appears high in one industry may be standard in another.
For example, a manufacturer might have a lower average ratio than a utility. Using the metric across industries without context can mislead the results.
Doesn’t Account for Off-Balance Sheet Liabilities
Some obligations, like lease commitments or guarantees, might not always appear directly on the balance sheet.
Since these debts still carry financial weight and can affect the business’s true leverage, ignoring them can understate the exposure.
Snapshot in Time
Debt-to-equity ratios reflect financial data from a single reporting period.
If debt levels or equity positions shift seasonally or due to one-time events, the ratio may not reflect the company’s ongoing situation. It’s useful, but only as part of a trend analysis.
Inconsistent Definitions
Some analysts include preferred stock as equity, while others treat it as debt due to fixed dividends and higher claims than common stock.
This inconsistency can affect debt-to-equity calculations and interpretations. Therefore, it’s crucial to clarify how these elements are handled in each analysis.
Doesn’t Indicate Future Performance
Even if the current ratio looks healthy, it doesn’t say much about what comes next. Future earnings, changes in interest rates, or shifts in market demand can all alter the risk profile.
This is why analysts need other forward-looking metrics to assess long-term prospects.
Preferred Stock Can Complicate the Debt-to-Equity Ratio
In sectors like utilities, high debt-to-equity ratios are common because of stable earnings and capital-intensive operations.
These businesses can handle more leverage without increasing risk. In this context, a high ratio may reflect efficient capital use rather than distress.
REITs Make Debt Analysis More Complex Due to Preferred Shares
Real estate investment trusts often rely on preferred stock. Including these shares as debt increases the D/E ratio, while counting them as equity lowers it.
The classification changes how risk is perceived, which makes debt evaluation in this sector more complicated than standard corporate analysis.
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How to Modify the Debt-to-Equity Ratio
One method of D/E adjustment is to focus on long-term debt only, excluding short-term liabilities.
The formula becomes:
Long-term debt ÷ Shareholder equity
This approach isolates the debt with more risk due to repayment length and interest rate exposure.
For example, compare two companies with $1.5 million in equity.
Company A has $1 million in short-term liabilities and $500,000 in long-term debt.
Company B has $500,000 in short-term liabilities and $1 million in long-term debt.
Both have the same standard D/E ratio of 1, but Company B is exposed to more long-term risk.
Short-term debt tends to be cheaper and less sensitive to interest rate changes.
Meanwhile, long-term debt often involves higher costs and greater uncertainty at renewal.
Rising interest rates also increase refinancing risk, especially when large long-term debts mature.
In contrast, short-term debt doesn’t raise immediate concern if the company is unlikely to default within the following year.
These dynamics generally depend on your strategic model, product cycles, and types of pricing used to manage profit margins and debt recovery timelines.
Therefore, evaluating long-term obligations provides better insight into whether a business can meet commitments well into the future.
This modification is also critical when aligning debt strategy with a company’s position in its business life cycle.
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How to Apply the Debt-to-Equity Ratio in Personal Finances
The debt-to-equity ratio also applies outside of business. In personal finance, equity means the difference between total assets and total liabilities.
The formula adjusts slightly:
Total Personal Liabilities ÷ (Personal Assets − Personal Liabilities)
This calculation is useful when comparing obligations such as student loans, subsidized and unsubsidized loans, and first-time homebuyer loans.
It also helps evaluate home loans, home improvement loans, and auto loans to see which loans are suitable for you and align with your equity position.
In addition, lenders review this ratio during credit evaluations.
It helps them estimate how well you can handle new debt if your income drops.
So, when your assets surpass your liabilities, you create a financial buffer that cushions you against sudden income gaps.
Whether you’re securing a mortgage, arranging a bridge loan, or taking on an electric vehicle financing that calls for collateral, the positive equity gives you room to maneuver.
Knowing you have more than what you owe means you can keep up with payments during unexpected cash-flow hiccups.
The same applies to applicants seeking business loans or credit lines, including secured loans or unsecured loans.
It can also inform your DIY debt plan, helping you choose between strategies like debt snowball or debt avalanche.
To get out of debt through debt settlement agreements, you might seek credit counseling or arrange a personal loan for debt consolidation.
Alternatively, you could navigate rejected loans or opt for a personal loan as another route.
Debt-to-Equity Ratio vs. Other Leverage Ratios
| Ratio | Formula | Purpose |
| Debt-to-Equity Ratio | Total Debt / Total Equity | Measures how much debt is used to finance equity |
| Debt-to-Assets Ratio | Total Debt / Total Assets | Shows what portion of assets are financed by debt |
| Debt-to-Capital Ratio | Total Debt / (Total Debt + Total Equity) | Reflects the proportion of capital structure made up of debt |
| Debt-to-EBITDA Ratio | Total Debt / Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) | Assesses a company’s ability to pay off debt using earnings |
| Asset-to-Equity Ratio | Total Assets / Total Equity | Evaluates how much of a company’s assets are funded by equity |
Debt-to-Equity Ratio vs. Gearing Ratio
| Aspect | Debt-to-Equity Ratio | Gearing Ratio |
| Definition | Total Debt divided by Total Equity | A broad term covering all ratios measuring financial leverage |
| Category | Type of Gearing Ratio | Category of Ratios |
| Focus | Balance between debt and equity financing | Overall financial leverage |
| Interpretation | Highlights reliance on external debt versus internal equity | Assumes some debt improves returns, but too much increases risk |
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Conclusion
The debt-to-equity ratio not only highlights the amount of debt, but it also measures the balance between external obligations and internal ownership.
This balance influences everything from borrowing power to investor confidence and long-term viability.
As such, this ratio should prompt the following questions:
Where is the debt going? What supports the equity? How will both shift over time?
Without tying the ratio to real capital use and repayment capacity, it may become a number with no functional insight.
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