Debt-to-Equity Ratio: Formula, Example, and Benchmark

The debt-to-equity ratio divides everything your business owes by the equity you have put into it. A result of 0.5 means you carry 50 cents of debt for every dollar of your own money in the business; a result of 2.0 means two dollars of debt for every dollar of equity. Lenders read it as a risk gauge: the more of your business that runs on borrowed money, the harder a bad quarter hits. For a freelancer or small operator deciding whether to take on a loan, that single number is a fast read on how much room you have left, which is why it sits next to liquidity measures like the current ratio on any lender's checklist.

The Business Development Bank of Canada states the formula plainly: "Debt-to-equity ratio = total liabilities / total shareholders' equity" (BDC). This guide defines each side, calculates the ratio on a realistic set of small-business numbers, explains what "equity" even means when you are a sole proprietor with no shareholders, and shows what benchmark lenders treat as healthy.

What Is the Debt-to-Equity Ratio?

The debt-to-equity ratio is a solvency measure. It answers one question: how much of your business did you fund with borrowed money versus your own? Both figures come off the balance sheet, which is built on a single identity. The U.S. Securities and Exchange Commission writes it as "ASSETS = LIABILITIES + SHAREHOLDERS' EQUITY" (U.S. Securities and Exchange Commission). Rearranged, equity is what remains after debt: everything you own minus everything you owe.

The SEC defines the two sides directly. "Liabilities are amounts of money that a company owes to others," and shareholders' equity "is the money that would be left if a company sold all of its assets and paid off all of its liabilities" (U.S. Securities and Exchange Commission). The ratio stacks the first against the second. A number below 1 means you have more equity than debt; a number above 1 means debt outweighs your stake.

Because both inputs come straight off the balance sheet, the ratio is only as honest as the bookkeeping under it. Miss a loan balance or forget an accrued tax bill and the number flatters you.

How to Calculate the Debt-to-Equity Ratio Step by Step

Add up what you owe, add up your equity, and divide. The wrinkle is deciding what counts as "debt," because there are two common versions of the numerator and they give different answers.

The broad version uses total liabilities, everything on the right side of the balance sheet above equity. The narrower version counts only interest-bearing debt and leaves out day-to-day operating balances. Corporate Finance Institute draws that line, listing the drawn line of credit, notes payable, current portion of long-term debt, bonds payable, long-term debt, and capital lease obligations as debt, while excluding "accounts payable, accrued expenses, deferred revenues, and dividends payable" (Corporate Finance Institute). The idea is that a supplier invoice due in 30 days is not the same kind of obligation as a five-year equipment loan.

Take a small print shop with these balances at year-end:

Owner's equity is $50,000. The two versions read like this:

• Total-liabilities ratio: $30,000 / $50,000 = 0.60
• Interest-bearing-debt ratio: $25,000 / $50,000 = 0.50

Neither is wrong. The total-liabilities figure is what most glossaries and lenders quote; the debt-only figure isolates the financing decisions you pay interest on. What matters is that you know which one you calculated and compare like with like, because a bank quoting 0.60 and you quoting 0.50 are describing the same shop.

What Counts as Equity When You Are a Sole Proprietor?

"Shareholders' equity" sounds like it belongs to corporations with stock certificates. A sole proprietor has no shares, but the equity is still there, and the ratio works the same way. The SEC puts it in plain terms: equity "is sometimes called capital or net worth," and it equals "the amount owners invested in the company's stock plus or minus the company's earnings or losses since inception" (U.S. Securities and Exchange Commission).

For a one-owner business that lives in a single owner's equity account (also called the capital account). It moves with three things:

• Contributions you put in, the cash and equipment you funded the business with.
• Profits the business keeps, which raise your equity.
• Owner's draws, the money you take out for yourself, which lower it.

Say you seeded the print shop with $20,000, it retained $40,000 of profit over its life, and you have drawn $10,000 for personal use. Your equity is $20,000 + $40,000 − $10,000 = $50,000, the figure used above. Draws are the lever most owners forget: pull cash out faster than the business earns it and your equity shrinks, which pushes the ratio up even when you have taken on no new debt.

One consequence follows straight from the accounting equation. If your liabilities ever exceed your assets, equity turns negative, and a debt-to-equity ratio built on a negative denominator stops meaning anything. At that point the ratio is not a small number to improve; it is a signal that the business owes more than it owns.

What Is a Good Debt-to-Equity Ratio?

There is no single right number, and any source that hands you one without asking about your industry is guessing. BDC uses a 2:1 ratio as its worked example and calls it "a good balance," meaning "$2 of debt for every $1 of shareholders' equity," but stresses that lenders judge a ratio "with that of other businesses in the same sector" (BDC). Corporate Finance Institute agrees the target is not universal: "The appropriate debt-to-equity ratio varies by industry" (Corporate Finance Institute).

Direction still matters. A low ratio points to a business that is closer to fully equity-financed and carries less risk if sales dip. A high ratio points to a debt-heavy business, and BDC spells out the downside: if revenues decline, such a company "may be unable to repay its debts" and "will also have trouble taking on new debt" (BDC).

Context sets the goalpost. A capital-heavy business, a trucking operation financing rigs, a shop fitting out a storefront, normally runs a higher ratio because the assets it borrows against hold their value. A service freelancer with a laptop and few loans should sit low, often well under 1, because there is little to borrow against and little reason to. Compare your ratio to your own trend and to businesses like yours, not to a textbook 2:1.

Common Misconceptions About the Debt-to-Equity Ratio

"The lower the ratio, the better." Zero debt is not automatically the strongest position. A sole proprietor who avoids borrowing entirely may be passing up financing that would let the business grow faster than retained profits allow. CFI notes that a high ratio "is quite preferable for a company that is stable with significant cash flow generation," because borrowed money put to productive use can earn more than it costs. The risk is debt you cannot service; debt you can is often worth taking.

"The ratio measures whether I can pay my bills." It does not, at least not the near-term ones. Debt-to-equity is a long-run capital-structure measure; whether you can cover this month's obligations is a liquidity question answered by the current ratio, which weighs short-term assets against short-term debts. A business can show a comfortable debt-to-equity ratio and still run short of cash if its money is tied up in slow-paying invoices.

"Accounts payable is not really debt." It depends on which version you are calculating. In the total-liabilities ratio a supplier invoice absolutely counts, and stretched payables inflate the number. That is why the debt-only version exists, and why letting net-30 balances pile up can quietly raise the ratio a lender sees even though you took out no loan.

How SparkReceipt Helps

SparkReceipt does not calculate your debt-to-equity ratio or manage your loans, and the ratio itself lives in your accounting software or a lender's spreadsheet. What it does is keep the records underneath the numbers accurate, because a ratio built on messy books misleads you and the bank alike. The business expense tracker captures and categorizes what you spend, including the interest and payments on the debt side, while the income tracker records the revenue that feeds retained profit on the equity side. Clean, current records mean the liabilities and equity totals you or your accountant plug into the ratio reflect reality rather than a stale guess. Ready to tidy up the numbers behind your ratios? Get Started.

Frequently Asked Questions

What is a debt-to-equity ratio of 1.5? It means your business carries $1.50 of debt for every $1.00 of owner's equity. Debt slightly outweighs your own stake, which is common and often fine, but whether it is healthy depends on your industry and how reliably your revenue covers the payments.

Is a higher or lower debt-to-equity ratio better? Lower generally means less risk, since more of the business is funded by your own equity. But a very low ratio can mean you are underusing financing that could fund growth. The goal is a level of debt your cash flow can comfortably service, judged against businesses like yours.

Should I use total liabilities or only loans in the ratio? Both are used. The total-liabilities version is the standard glossary and lender figure; the interest-bearing-debt version excludes operating balances like accounts payable to isolate borrowing you pay interest on. Pick one, label it, and be consistent so your number is comparable over time.

Can a sole proprietor have a debt-to-equity ratio? Yes. A sole proprietor has no shares, but equity still exists as the owner's capital account: contributions plus retained profits minus draws. The ratio divides total liabilities by that equity exactly as it would for a corporation.

What does a negative debt-to-equity ratio mean? It usually means equity is negative, because liabilities exceed assets. The ratio loses its normal meaning at that point and signals that the business owes more than it owns, which is a solvency concern rather than a fine point about debt levels.

Key Takeaways

• The debt-to-equity ratio is total liabilities divided by owner's equity, and it measures how much of your business is financed by debt versus your own money.
• Two versions exist: total liabilities gives the standard figure, while counting only interest-bearing debt isolates the financing you pay interest on. Label which one you used.
• A sole proprietor's equity is the owner's capital account, contributions plus retained profits minus draws, so heavy owner's draws raise the ratio without any new borrowing.
• There is no universal "good" ratio. Lenders and both BDC and CFI judge it against your industry; a capital-heavy trade runs higher than a laptop freelancer.
• Debt-to-equity measures long-run capital structure, not whether you can pay this month's bills, and both inputs are only as accurate as the bookkeeping behind them.