The Beginner’s Guide to Debt-to-Equity Ratio

Have you heard of debt-to-equity ratio? Not to be confused with loan-to-value (LTV) ratio, it represents financing sources. You can finance your business, of course, with debt and equity. Assuming you use both types of financing, you may want to calculate your business’s debt-to-equity ratio. It will provide you with a better understanding of how your business is financed.

The Beginner’s Guide to Debt-to-Equity Ratio

Overview of Debt-to-Equity Ratio

Debt-to-equity ratio represents the amount of debt with which a business is financed relative to the amount of equity with which the business is financed.

With debt-to-equity ratio, you’ll know much debt financing your business has relative to its equity financing. A debt-to-equity ratio of 3:1, for instance, means that for business has three times as much debt financing as equity financing. For every $1 in equity financing, your business will have $3 in debt financing.

How to Calculate Debt-to-Equity Ratio

The formula for debt-to-equity ratio is simple. To calculate your business’s debt-to-equity ratio, you just need to know your business’s total debt financing and its total equity financing.

You can calculate debt-to-equity ratio by adding up all of your business’s debt and dividing this number by your business’s total equity financing. Debt can include business loans, lines of credit and credit cards. Equity financing, on the other hand, involves the sale of partial ownership of your business to an investor or investment firm.

What’s a Good Debt-to-Equtiy Ratio?

You might be wondering what’s a good debt-to-equity ratio. For starters and other early-stage businesses, a debt-to-equity ratio of 1.5 to 2 is considered good.

Many business owners make the mistake of using too much equity financing and not enough debt financing. They end up selling a large portion of their respective business to investors, resulting in a low debt-to-equity ratio. While there’s nothing wrong with using equity financing to raise capital, you should consider how much equity financing your business has raised versus its debt financing.

Too much equity financing and too little debt financing means you’ll have to give up a substantial amount of business. Equity financing doesn’t involve borrowing money. While there are different types of equity financing vehicles, they all involve the sale of ownership to an investor or investment firm. Keeping your business’s debt-to-equity raito around 1.5 to 2 will ensure that you retain ownership of your business.

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