Debt-to-equity ratio: Definition, formula, and interpretation

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. Lenders check D/E ratios before approving loans, investors use them to assess risk exposure, and business owners rely on this metric to maintain healthy capital structures.

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 (D/E) 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.

This ratio reveals how a company structures its capital base and manages financial risk. Companies with higher ratios depend more on creditors, while those with lower ratios rely primarily on shareholder contributions and retained earnings to fund their operations.

Key components of the D/E ratio

Total liabilities represent all debts and financial obligations a company owes to external parties. This includes short-term debts such as accounts payable and accrued expenses, long-term debts such as bonds and mortgages, and lease obligations. Some analysts exclude certain liabilities such as deferred tax obligations when calculating industry-specific ratios.

Shareholder equity comprises the residual value that belongs to owners after subtracting all liabilities from total assets. This includes common stock, preferred stock, retained earnings, and additional paid-in capital. Treasury stock, which represents shares the company has repurchased, reduces total equity.

The standard D/E ratio includes all liabilities, but some analysts prefer modified versions that focus only on interest-bearing debt and exclude operating liabilities like accounts payable. The most common error involves conflating book value equity with market capitalization. Debt-to-equity ratios always use balance sheet equity figures rather than stock market valuations.

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 $50,000 in total liabilities and $50,000 in shareholder equity. Here’s what it would look like on your balance sheet:

Using the numbers from this balance sheet, you calculate the debt-to-equity ratio as:

Debt-to-equity ratio = 50,000 / 50,000 = 1.0

That means your company carries $1 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.

Modified D/E ratio calculations

Some analysts use modified versions of the debt-to-equity ratio to better isolate financial risk or reflect industry-specific capital structures.

The long-term debt-to-equity ratio narrows the focus to debts with maturities beyond one year, excluding short-term obligations such as current accounts payable and short-term notes. This variation provides clearer insight into a company’s permanent capital structure and long-term leverage commitments rather than temporary working capital fluctuations.

Analysts may also exclude certain liabilities when they want to separate financing risk from operational obligations. Interest-bearing debt typically receives more attention than non-interest liabilities because it creates fixed payment obligations and increases financial leverage. Deferred revenue and pension liabilities are sometimes excluded depending on the purpose of the analysis and the industry context.

Financial institutions and capital-intensive industries often rely on specialized D/E calculations that reflect their unique balance sheets. Banks may exclude customer deposits since deposits function differently from traditional borrowing. Real estate investment trusts adjust for property values and lease obligations, while manufacturing companies may focus primarily on bank debt and bonds when evaluating leverage risk.

Alternative formulas used by banks

Banks and lenders often apply variations of the debt-to-equity ratio to refine how they assess leverage and borrowing capacity:

• 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. This variation highlights a company’s true debt servicing burden.
• Net debt-to-equity: Subtracts cash and cash equivalents from total debt before dividing by equity. This approach recognizes that liquid assets can offset borrowing needs and is 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 isolates leverage tied to debts that must be repaid first in bankruptcy, helping lenders evaluate downside risk.

These variations help lenders assess borrowing capacity, covenant risk, and debt service ability. Understanding which formula your lender uses makes it easier to anticipate how leverage will be evaluated during credit reviews.

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

You can calculate the debt-to-equity ratio in three steps using figures from your company’s balance sheet. This process works for small businesses, large companies, and spreadsheet-based analysis.

1. Gather balance sheet data

Find total liabilities in the liabilities section of your financial statements. Then locate total shareholders’ 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

Divide total liabilities by shareholders’ equity. For example, if liabilities are $750,000 and equity is $500,000, the calculation looks like this:

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

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

3. Calculate the ratio in Excel or Google Sheets

Create a simple template with cells for liabilities and equity. In a new cell, use the formula =liabilities/equity to calculate the ratio automatically. Updating these figures regularly helps you track leverage trends and monitor changes in financial risk.

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

A range of 1.0–1.5 is often considered healthy, but there isn’t a single “good” debt-to-equity ratio for every company. What qualifies as a good ratio depends on your industry, business model, and tolerance for financial risk. Capital-intensive industries such as airlines, utilities, and real estate typically carry higher ratios because they rely on large, long-term assets financed with debt.

A “good” debt-to-equity ratio also depends on growth stage. Early-stage companies often rely more on equity funding, while mature businesses may take on more debt once cash flow is predictable and assets can support borrowing.

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

Typical debt-to-equity ratios by industry

Here’s a sampling of D/E ratios for well-known companies that fall into some of those categories:

• Amazon: 0.4
• Alphabet (Google): 0.1
• Microsoft: 0.3
• United Airlines: 2.0

How lenders and investors use the D/E ratio

The debt-to-equity ratio plays a central role in how outsiders assess your company’s financial risk and stability. Lenders and investors use it to evaluate borrowing capacity, valuation, and downside exposure.

Bank covenant thresholds

Lenders often set maximum debt-to-equity 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. Exceeding these limits can trigger higher interest rates, stricter terms, or default provisions.

Banks monitor this ratio through periodic covenant compliance reporting. If your ratio approaches the threshold, lenders may require corrective action plans or impose additional restrictions. Some agreements include step-down provisions that gradually reduce allowable leverage over the life of the loan.

Equity valuation multiples impact

Leverage directly affects how investors value a business. Higher debt-to-equity ratios often reduce valuation multiples because debt increases financial risk and constrains flexibility. Investors tend to discount companies that rely heavily on borrowing, particularly when earnings are volatile.

Private equity buyers incorporate leverage into return models and deal pricing. Strategic acquirers may also discount highly leveraged targets due to refinancing risk and integration complexity. Lower ratios typically support higher valuations by signaling balance sheet strength and financial flexibility.

Credit rating considerations

Credit rating agencies consider the debt-to-equity ratio when assessing creditworthiness. Investment-grade ratings generally require lower leverage, though acceptable thresholds vary by industry. Higher ratios increase borrowing costs by pushing companies toward speculative ratings.

Agencies also evaluate trends over time and peer comparisons. Improving ratios can support rating upgrades, while sustained increases in leverage may lead to downgrades. Credit ratings influence 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 useful leverage metric, but it can be misleading if you don’t account for context, accounting treatment, and industry norms.

Lease liabilities under ASC 842

ASC 842 requires most operating leases to be recorded as liabilities on the balance sheet. This change increased reported total liabilities for many retailers, restaurants, and real estate businesses, which can inflate debt-to-equity ratios without reflecting a real increase in borrowing. Comparing ratios across periods or against peers requires consistent lease treatment.

Negative equity scenarios

When accumulated losses exceed investor capital, shareholder equity becomes negative. In these cases, the denominator in the ratio no longer provides meaningful insight. A company may carry limited debt but still show a distorted or negative debt-to-equity ratio. Lenders and investors often rely on liquidity, cash flow, or the current ratio instead.

Book value versus market value

The debt-to-equity ratio relies on book value equity from financial statements, which may not reflect a company’s economic value. Assets recorded at historical cost can understate true worth, while intangible assets such as brands and customer relationships often carry little balance sheet value. As a result, book-based ratios may overstate leverage for asset-light or brand-driven businesses.

Industry norms and trend analysis

A single debt-to-equity ratio snapshot provides limited insight without industry benchmarks and trend analysis. Capital-intensive sectors such as utilities and telecommunications often operate with ratios above 2.0, while technology companies commonly remain below 0.5.

Tracking how the ratio changes over time is equally important. A steadily rising ratio may signal aggressive expansion or declining profitability, while a declining ratio can reflect deleveraging or improving earnings. Evaluating trends alongside revenue growth, margins, and cash flow provides a more complete picture of financial risk.

Debt-to-equity ratio vs. other leverage metrics

The debt-to-equity ratio is one of several metrics used to assess leverage. Comparing it with related leverage and liquidity ratios provides a clearer view of how a company finances its operations and manages financial obligations.

How to improve your debt-to-equity ratio

Improving your debt-to-equity ratio strengthens your balance sheet and can improve access to financing. These strategies focus on managing both sides of the equation: total liabilities and shareholders’ equity.

1. Refinance short-term debt to long-term facilities: Short-term liabilities increase 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: Higher net income increases retained earnings, which flows directly into shareholders’ equity. Improving margins, reducing overhead, or adjusting pricing can strengthen equity without raising outside capital.
3. Use equity financing for growth instead of new loans: Raising capital through equity investors or preferred shares lowers leverage and signals stability to lenders and investors
4. Sell underutilized assets to pay down obligations: Selling unused equipment, property, or excess inventory generates cash that can reduce debt and improve returns on remaining assets
5. Tighten working capital management: Faster collection of accounts receivable and better accounts payable management can reduce reliance on short-term borrowing. Improving the cash conversion cycle supports liquidity and lowers financing needs.
6. Avoid debt-funded share buybacks: Repurchasing shares with borrowed money increases debt while reducing equity, pushing the ratio higher and increasing financial risk
7. Negotiate with lenders for flexibility: Lenders may allow covenant waivers, lower interest rates, or extended maturities if you present a credible plan to improve leverage and cash flow
8. Adopt real-time financial controls: Better visibility into spending helps prevent unnecessary borrowing and supports proactive leverage management before debt becomes a red flag

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.