Debt-to-equity ratio: Formula, calculation, and how to interpret it

The debt-to-equity ratio is a core financial metric that shows how much debt a company uses compared with equity to fund its operations.

This leverage ratio highlights your company’s financial risk and overall financial health. A high D/E ratio can signal higher debt obligations, greater exposure to interest rates, and pressure on cash flow. A lower ratio suggests stronger liquidity and less dependence on borrowing.

What is the debt-to-equity ratio?

The debt-to-equity ratio is a financial metric that compares a company’s total liabilities to shareholder equity on the balance sheet. It shows how much of your company’s assets you finance through debt financing versus equity financing.

This leverage ratio signals how heavily you rely on borrowing to fund operations. The ratio formula divides total liabilities by shareholder equity, which can be found on your balance sheet. A ratio of 1.5 means the company carries $1.50 in debt financing for every $1 of equity financing.

Lenders review this ratio when setting loan terms, while investors use it to evaluate valuation and stability. Track your debt-to-equity ratio calculation over time to benchmark against peers, spot red flags on your company’s balance sheet, and make smarter capital decisions.

Total debt defined

Total debt represents all borrowing a company reports on its balance sheet. It combines short-term liabilities, such as accounts payable, accrued expenses, and the current portion of loans, with long-term debt such as bonds, mortgages, and equipment financing.

Together, these items reflect the full amount of your debt obligations and your reliance on borrowed capital. Tracking both short- and long-term borrowing helps assess leverage and your company’s ability to manage future repayments.

Shareholders equity defined

Shareholder equity is the portion of your company’s value owned by investors after paying off all debt obligations. It includes contributed capital plus retained earnings from profitable operations.

You’ll find it at the bottom of your balance sheet, calculated as total assets minus total liabilities. Because equity reflects ownership rather than borrowing, it anchors the denominator in the debt-to-equity ratio calculation and shows how much of the business you fund internally.

Debt-to-equity ratio formula

The debt-to-equity ratio formula is simple, but each part tells you something different:

Debt-to-equity ratio = Total liabilities / Shareholder equity

Total liabilities include short-term debt, long-term debt, accounts payable, and other debt obligations. It shows your company’s reliance on debt financing.

Shareholder equity reflects reliance on equity financing. It’s your total assets minus your total liabilities, and includes investor capital, retained earnings, and sometimes preferred shares.

Example calculation

Let’s say your company reports $500,000 in total liabilities and $250,000 in shareholder equity:

Debt-to-equity ratio = 500,000 / 250,000 = 2.0

That means your company carries $2 in debt for every $1 of equity. In general, a higher debt-to-equity ratio signals more borrowing, higher financial risk, and a greater cost of capital, while a lower ratio suggests stronger liquidity and less pressure from debt servicing.

Alternative formulas used by banks

Banks and lenders often use variations of the debt-to-equity ratio to refine their view of leverage:

• Interest-bearing debt-to-equity: Excludes non-interest liabilities such as accounts payable, focusing only on loans and other debt that require regular interest payments. It helps highlight your company’s true debt servicing burden.
• Net debt-to-equity: Subtracts cash and cash equivalents from total debt before dividing by equity. This variation recognizes that liquid assets can offset borrowing needs. It’s useful for companies with large cash reserves or seasonal cash flow cycles.
• Senior debt-to-equity: Considers only priority debt obligations, such as secured loans. It reveals leverage tied to obligations that you must repay first in bankruptcy, helping lenders measure your company’s ability to cover its most critical debts.

These variations help banks assess your true borrowing capacity and debt service ability. Understanding which formula your lender uses helps you prepare stronger loan applications.

How to calculate the debt-to-equity ratio step by step

You can calculate the debt-to-equity ratio in three quick steps using numbers from your company’s balance sheet. This process works for small businesses, large corporations, and even in a simple Excel template.

1. Gather balance sheet data

Find total liabilities in the liabilities section of your financial statements. Then, locate total shareholder equity, usually listed at the bottom of the balance sheet as total assets minus total liabilities. Use figures from the same reporting date to ensure accuracy.

2. Plug numbers into the ratio formula

Take your total liabilities and divide by shareholder equity. For example, if liabilities are $750,000 and equity is $500,000, your debt-to-equity ratio calculation is:

Debt-to-equity ratio = 750,000 / 500,000 = 1.5

That means the company carries $1.50 in debt for every $1 of equity.

3. Compute debt-to-equity ratio in Excel or Google Sheets

Set up a simple template with cells for “liabilities” and “equity.” In a new cell, use the formula =liabilities/equity to calculate the ratio automatically. Updating the numbers each quarter helps you track leverage trends and monitor the company’s financial health.

What is a good debt-to-equity ratio for your industry?

There isn’t a single “good” debt-to-equity ratio for all companies. A good debt-to-equity ratio depends on your industry, business model, and tolerance for financial risk. Capital-intensive industries, such as airlines, utilities, and real estate, often carry a higher debt-to-equity ratio because they rely on large, long-term assets.

In contrast, service firms and software companies usually maintain lower ratios because they scale without heavy borrowing.

Typical debt-to-equity ratios by industry

How lenders and investors use the D/E ratio

The debt-to-equity ratio is more than a number. It shapes how outsiders judge your company’s risk and value. Both lenders and investors rely on it to make funding decisions.

Bank covenant thresholds

Lenders set maximum D/E ratio limits in loan agreements to protect their interests. Typical covenant thresholds range from 1.0 to 3.0, depending on your industry and creditworthiness. Breaching these limits can trigger default provisions, higher interest rates, or demands for immediate repayment.

Banks monitor your ratio quarterly through covenant compliance certificates. They may require corrective action plans if you approach threshold limits. Some agreements include step-down provisions that gradually reduce allowable ratios over the loan term.

Equity valuation multiples impact

High leverage directly affects how investors value your company. Each point increase in your D/E ratio typically reduces valuation multiples by 10–20%. Investors view excessive debt as constraining growth potential and increasing bankruptcy risk.

Private equity buyers factor your leverage into their return models and offer prices. Strategic acquirers may discount heavily leveraged targets due to integration complexities. Lower ratios generally command premium valuations by signaling financial flexibility and stability.

Credit rating considerations

Credit agencies weight D/E ratios heavily when assigning creditworthiness ratings. Investment-grade ratings typically require ratios below 2.0, though this varies by industry. Higher ratios push companies toward speculative grades, increasing borrowing costs.

Rating agencies also evaluate ratio trends and peer comparisons. Improving ratios can trigger rating upgrades, while deterioration prompts downgrades. Your credit rating directly impacts bond yields, loan pricing, and access to capital markets.

Limitations and common pitfalls of the D/E ratio

The debt-to-equity ratio is a valuable metric, but it has limitations that can distort results if you don’t account for context.

Lease liabilities under ASC 842

Accounting rules now require companies to record operating leases as liabilities on the company’s balance sheet. This change increased reported total liabilities for many retailers, restaurants, and real estate firms. Comparing today’s ratios with pre-ASC 842 numbers can be misleading without adjustments.

Negative equity scenarios

When accumulated losses exceed investor capital, shareholder equity turns negative. This makes the denominator in the ratio formula meaningless. A company may have limited debt obligations yet still show a distorted or negative D/E ratio. In these cases, lenders and investors look instead at liquidity, cash flow, or the current ratio to judge financial health.

Book value vs. market value

The D/E ratio relies on the book value of equity from financial statements, which may not reflect a company’s true worth. Assets purchased decades ago remain at historical cost even if their market value has risen sharply. Meanwhile, intangible assets like brands or customer relationships often carry little balance sheet value.

Using only book values can understate equity and inflate the leverage picture.

Debt-to-equity ratio vs. other leverage metrics

The D/E ratio is just one way to measure leverage. Comparing it with related ratios and liquidity ratios gives a clearer view of a company’s ability to manage financial obligations.

8 ways to improve your debt equity ratio

Improving your debt-to-equity ratio strengthens your company’s balance sheet and helps you qualify for better financing. These strategies focus on managing both sides of the equation: Total debt and shareholder equity.

1. Refinance short-term debt to long-term facilities

Short-term liabilities raise leverage risk because they come due quickly. Converting them into long-term loans or a revolving line of credit spreads repayment over time, improves liquidity, and reduces covenant pressure.

2. Increase retained earnings through profitability

Boosting net income directly increases retained earnings, which flows into shareholder equity. Expanding margins, reducing overhead, or optimizing pricing are practical ways to strengthen equity without raising outside capital.

3. Use equity financing for growth instead of new loans

Consider raising funds through equity investors or issuing preferred shares instead of piling on additional debt financing. This lowers leverage and signals stability to lenders and investors.

4. Sell underutilized assets to pay down obligations

Liquidating equipment, property, or inventory you no longer need generates cash that can retire debt. This reduces total liabilities and improves return on the company’s assets still in use.

5. Tighten working capital management

Faster collection of accounts receivable and better management of accounts payable can reduce reliance on short-term borrowing. Improving the cash conversion cycle supports liquidity and lowers the need for external debt.

6. Avoid debt-funded share buybacks

Repurchasing stock with borrowed money raises total debt while reducing shareholder equity, pushing the ratio higher. Prioritize reinvesting profits into operations or debt repayment instead of financial engineering.

7. Negotiate with lenders for flexibility

Banks may allow covenant waivers, lower interest rates, or extended maturities if you present a credible plan to improve leverage. These adjustments give you more room to manage debt obligations without immediate strain.

8. Adopt real-time financial controls

Modern spend management tools give visibility into expenses, highlight unnecessary borrowing, and help avoid overspending. Proactive monitoring of cash flow keeps leverage in check before it becomes a red flag in your financial statements.

How Ramp streamlines debt-to-equity ratio management

Calculating and monitoring your debt-to-equity ratio sounds straightforward until you're actually trying to pull accurate, real-time data from multiple systems. You need current liability figures from various credit sources, up-to-date equity calculations, and the ability to track how operational decisions impact these numbers.

Ramp's finance operations platform addresses these challenges by centralizing your financial data and providing real-time visibility into spending patterns that directly affect your balance sheet. When you use Ramp's corporate cards and bill pay features, every transaction automatically flows into your financial reporting, eliminating the manual data entry that often leads to errors in liability tracking.

That means you can see exactly how much you're spending on credit at any given moment, making it easier to calculate the debt portion of your ratio accurately.