What is the debt-to-equity ratio – Key Metric for Financial Health

The debt-to-equity ratio shows how much money a company has borrowed compared to the money invested by its owners. It compares a company’s debts to its shareholders’ equity, which is the owners’ share of the business.

Why This Metric Matters
 

• For Investors: The ratio helps investors understand the level of risk associated with a company. If a company borrows too much, it may struggle to repay its debts during tough economic times. Investors use this information to decide if they want to invest or not.
   
• For Companies: Businesses use the debt-to-equity ratio to decide the best way to finance their operations. They try to find a balance between borrowing money and using their capital to keep costs low and stay flexible.
   
• For Fintech Platforms: Online lending and investment platforms use this ratio to check how risky a borrower is. It helps them decide whether to offer loans or investments and to manage overall risk on their platforms.

The debt-to-equity ratio helps everyone, from investors to companies and fintech firms, make smarter financial decisions by showing how much a company depends on debt compared to its own money. 

In this blog, you will learn what the debt-to-equity ratio is and why it is a key metric for maintaining good financial health.

How to Calculate Debt-to-Equity Ratio: Step-by-Step Guide

The debt-to-equity ratio shows how much money a company borrows compared to how much money the owners have invested. It helps us understand how risky the company’s finances are.

What You Need to Know

To calculate the debt-to-equity ratio, you need two things from the company’s balance sheet:

1. Total Liabilities (Debt): This is the total amount the company owes, like bank loans, bonds, or other borrowings.

2. Shareholders’ Equity: This is the money that the company’s owners (shareholders) have invested, including share capital and profits kept in the business.

The Formula: Debt-to-Equity Ratio = Total Liabilities/ Shareholders’ Equity

This shows how much debt the company has for every ₹1 of the owner’s money.

Example: ABC Company 

Let’s say ABC Company, based in India, has the following numbers on its balance sheet:
 

• Current Liabilities: ₹20,00,000
• Long-term Liabilities: ₹30,00,000
  Total Liabilities = ₹50,00,000
   
• Share Capital: ₹15,00,000
• Retained Earnings: ₹25,00,000
  Total Shareholders’ Equity = ₹40,00,000
   

Now, calculate the ratio:

Debt-to-Equity Ratio = ₹50,00,000/ ₹40,00,000 = 1.25

What Does This Mean?

ABC Company has ₹1.25 in debt for every ₹1 the owners have invested. This shows a moderate level of risk. The company is using both debt and owner’s money to run the business.

Why Debt-to-Equity Ratio is Crucial for Financial Health

The debt-to-equity (D/E) ratio shows how much a company borrows compared to how much money the owners invest. It’s one of the most important tools for judging a company’s financial strength.

1. Impact on Company Stability and Growth

A company with too much debt might struggle to pay interest and loan repayments, especially during tough times. This weakens the company and makes it harder to grow.

On the other hand, a company with balanced debt and equity has more freedom to invest, expand, or handle unexpected costs.

The debt-to-equity ratio helps business owners decide how much to borrow without taking on too much risk.

2. Role in Creditworthiness and Investment Risk

Banks, lenders, and investors check this ratio before giving loans or investing money.

• If the ratio is high, lenders might charge higher interest or refuse loans because they see the company as risky.
   
• If the ratio is low, it shows the company is stable and can handle its debts well.

Investors also use this ratio to understand how risky it is to invest in the company. A company with lots of debt might make big profits during good times, but could also lose money fast during bad times.

Example: PQR Industries

Let’s say PQR Industries shows the following on its balance sheet:

• Total Liabilities (Debt): ₹80,00,000
• Shareholders’ Equity: ₹50,00,000

We use the formula:

Debt-to-Equity Ratio =  ₹80,00,000/ ₹50,00,000 = 1.6

What does this mean?
 

• For every ₹1 the owners invested, the company borrowed ₹1.60.
   
• This is quite a high level of debt. It may help the company grow faster, but it also brings higher financial risk.
   
• Banks might hesitate to lend more, and investors may ask for a higher return to cover the risk.
   

How Fintech Tools Help You Analyse Debt-to-Equity Ratios

Fintech tools make it easy to check a company’s debt-to-equity ratio. These apps and platforms save time, reduce mistakes, and give real-time insights. They help investors, business owners, and analysts understand how much debt a company has compared to the money invested by its owners.

Here are some of the popular fintech apps and platforms offering financial ratio analysis.

1. Source table

SourceTable is like a smart spreadsheet. You can upload your financial data or connect it to your accounts. Just type a question like “What is my debt-to-equity ratio?” and it answers instantly. It also shows charts, trends, and how your ratio compares with other companies in your industry.

2. Lucid Financials (or similar tools)

Lucid connects to software like QuickBooks or Zoho Books. It automatically tracks your financial data and updates your debt-to-equity ratio as things change. It alerts you when your ratio becomes too high and lets you test “what-if” situations, for example, “What happens if I borrow ₹10,00,000 more?”

3. Accounted Ratio Calculator

This tool lets you enter your data manually and instantly shows your ratio. It creates clear charts and reports, which you can download as PDFs, great for presentations or meetings.

Why These Tools Are Useful
 

• They save time: You don’t need to do manual calculations in Excel.
   
• They reduce errors: Automatic updates mean fewer mistakes.
   
• They give real-time insights: You can see your ratio change as your finances change.
   
• They help with decisions: You can try different financial plans and see how they affect your ratio.
   
• They compare you to others: You can see how your company stacks up against others in the same industry.
   

Limitations of Debt-to-Equity Ratio: What Fintech Investors Should Know

While the debt‑to‑equity (D/E) ratio offers insight into a company’s leverage, it can be misleading when used alone. Prime limitations include:

Fintech dashboards combine these metrics in one place, giving a complete and real-time view of a company’s financial health, far beyond what the D/E ratio alone can tell you.

Conclusion

The debt-to-equity ratio is a key tool for judging a company’s financial strength. While it gives a quick view of how much a company relies on debt, it doesn’t tell the whole story. Fintech tools now make it easier to track this ratio in real time and compare it with other useful financial indicators. To make better financial decisions, always use this ratio along with other data like cash flow, profits, and industry benchmarks.

FAQs

1. Can a company have a negative debt-to-equity ratio?

Yes, it can. This happens when the company has negative equity, usually because its losses are more than what the owners have invested. It’s a warning sign of serious financial trouble.

2. What is a good debt-to-equity ratio for small businesses?

A ratio between 0.5 and 1.5 is often seen as healthy, but it depends on the industry. Service-based businesses tend to keep lower ratios, while manufacturing firms might operate with higher ones.

3. How do fintech apps help track the debt-to-equity ratio?

Fintech apps pull data from your accounts automatically, calculate the ratio instantly, and update it in real time. They also show trends, compare with industry peers, and give alerts if your ratio goes too high.

4. Can a high debt-to-equity ratio ever be a good thing?

Sometimes, yes. If a company uses borrowed money wisely to grow and earns strong profits, a high ratio might work in its favour. But it also increases risk, so the company must manage debt carefully.
 

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LoansJagat Team

‘Simplify Finance for Everyone.’ This is the common goal of our team, as we try to explain any topic with relatable examples. From personal to business finance, managing EMIs to becoming debt-free, we do extensive research on each and every parameter, so you don’t have to. Scroll up and have a look at what 15+ years of experience in the BFSI sector looks like.