What Is ​a Good Business Debt-To-Equity Ratio?

When lenders and potential investors review your business, they look at a few key pieces of financial information. Your debt-to-equity ratio is one important figure because it's a sign of whether you can keep up with your bills.

Understanding how to maintain a good debt-to-equity ratio can help you improve not only your access to financing but your overall business operations. Here's how.

What is a debt-to-equity ratio?

The debt-to-equity ratio is a calculation that divides your business's total outstanding debts by its current equity. Both of these figures should be listed on the balance sheet in your financial statements.

If you don't already have this information, you can determine your equity by adding all up your assets—everything your business owns—and subtracting your liabilities, or everything you owe. The difference is your equity, which is the value of your business left for the owners if you sold everything today and paid off your debts.

For example, let's say a business has $2 million in assets and $1 million in total liabilities. This makes its equity $1 million and its debt-to-equity ratio 1:1.

Why it's important for businesses

A debt-to-equity ratio shows how much of your company has been funded using debt versus how much has been funded through equity, investors and company profits. Debt is a riskier form of funding because you're required to keep up with the scheduled loan payments—it's not optional like paying a profit dividend to shareholders. If you miss payments, creditors could sue, seize your assets or potentially bankrupt your company.

A good debt-to-equity ratio is a sign that you can manage debt payments and that you still have room to borrow—in other words, that you haven't maxed out your credit limits. A good ratio may also help you qualify for other loans and attract investors. If your debt-to-equity ratio is too high, lenders and investors might find your business too risky for future investments.

Understanding your ratio

The benchmark for a good debt-to-equity ratio depends partly on your industry. If you run a business that doesn't require much physical equipment, like a software firm, it's common to expect a lower debt-to-equity ratio—typically below 2:1. On the other hand, manufacturers typically have higher debt-to-equity ratios because they need to borrow more for equipment, machines, buildings and other physical assets.

Check the industry average for your type of business to determine a good debt-to-equity ratio. For example, a 3:1 ratio might be considered too high for a software company but reasonable for a manufacturer.

It's also possible to have a ratio that's too low. If your ratio is well below 1:1, investors might be concerned that you aren't actively growing your business with debt or that you've sold off too much equity to other investors. An ideal debt-to-equity ratio is based on balancing both types of financing.

Tips to improve your ratio

If you're worried about your debt-to-equity ratio being too high, one way to trim it down is by paying off debt. While this may be easier said than done, it's the simplest way to lower your ratio. It's also helpful to calculate whether it makes sense to consolidate your debt. Consider working on your ratio before applying for a new loan or trying to bring on investors.

Also remember that not all debt is equal when it comes to risk. High-interest, unsecured debt like a credit card is more expensive and riskier than a secured equipment loan with a lower interest rate. Investors and lenders could be more accepting of a higher ratio if it's from safer debt, so prioritize paying off unsecured loans.

Also pay attention to your ratio over time. If it's trending upward, ask yourself whether it was from planned borrowing or a growing financial issue. The earlier you catch potential debt troubles, the easier it is to keep them from spiraling.

Working toward the right debt-to-equity ratio for your business is less about the exact number and more about making sure you can keep up with debt payments based on current income and equity. A tax professional or business banker can help you create a strategy to improve your ratio and better understand your financial metrics.