How to Calculate Your Debt-to-Equity Ratio

Lenders use a variety of factors to determine whether or not to approve the money you’re requesting. Each factor reveals certain aspects of your financial habits, which combine to provide a more comprehensive view. Like it or not, your history usually plays a crucial role in determining your future.

Lenders often review your:

• Personal credit: Reveals credit history, credit in use, amounts owed, and payment history.
• Personal debt coverage: Reveals the balance between your cash flow and debt payments.
• Business debt coverage: Reveals the balance between your company’s cash flow and debt payments.
• Personal debt usage: Reveals how much credit is available that you’re not utilizing.
• Business debt usage: Reveals how much credit is available that your business is not utilizing.
• Business revenue trend: Reveals your business’s average revenue growth over time.

Measuring Your Reliance on Debt Financing

Another important factor lenders consider is your debt-to-equity ratio. Among other things, this factor shows the amount of skin you have in the game.

“The debt-to-equity ratio indicates how much debt and how much equity a business uses to finance its operations,” explains a business finance guide from The Balance Small Business. “A company’s debt is its long-term debt such as loans with a maturity of greater than one year. Equity is shareholder’s equity or what the investors in your business own.”

By comparing a business’s debt to its equity, a lender or investor can see just how reliant you are on debt financing. And it’s one of those rare scenarios where more is definitely not the merrier. The lower the ratio, the more stable the business.

You can calculate the debt-to-equity ratio by dividing your total liabilities by your total equity. The ratio is most relevant when considered within your industry benchmark. This comparison is important because certain industries rely on debt financing more than others. So it could be misleading to see a high debt-to-equity ratio for a manufacturing business because the manufacturing industry is known to rely more on debt financing.

“The debt-to-equity ratio shows a company’s debt as a percentage of its shareholder’s equity,” says The Balance Small Business. “If the debt-to-equity ratio is less than 1.0, then the firm is generally less risky than firms whose debt-to-equity ratio is greater than 1.0. If the company, for example, has a debt-to-equity ratio of .50, it means that it uses 50 cents of debt financing for every $1 of equity financing. Firms whose ratio is greater than 1.0 use more debt in financing their operations than equity. If the ratio is less than 1.0, they use more equity than debt.”

While the amount of debt used by your business is relevant to lenders, they’ll also pay close attention to what kind of debt it is. Are the loans long term loans or short term loans? How much of an impact will interest rate fluctuations have on the debt? Answering these questions helps a lender make their approval decisions.

Don’t Be Hindered by a High Debt-to-Equity Ratio

Perhaps you have a debt-to-equity ratio that’s considered high for your industry. It’s important to note that there’s a family of loan products predicated more on your present and future than on your past. For this reason, these loans are ideal for small business owners who have poor credit or don’t quite fit the profile most lenders are looking for.

• Business line of credit: Much like a credit card, this type of financing connects you with a revolving amount of cash that you can use at your leisure. You can qualify for up to $500,000. The rates can be on the steeper side, ranging from 8% on up to 24%.

To qualify, you’ll need a credit score of at least 560. Additionally, your business will need to have been around for at least 6 months and bring in $50,000 annually.

• ACH loan: These loans are known as cash flow loans because they’re approved based on the balance in your bank account each day. As a result, your credit history and debt-to-equity ratio are less important in the approval decision.

This loan is one of the fastest types of financing around, with money hitting your account within a couple of days. On a daily or weekly basis, a payment will be automatically sent to the lender from your bank account as an ACH deduction.

• Merchant cash advance: With a merchant cash advance, you borrow against your business’s future earnings. You can qualify for up to $200,000 with interest rates starting at 18%. Your payments will be based on a percentage of your credit card deposits each day. 

Lenders will ask for 4–6 months of bank statements or receivables in making their approval decision. Often, lenders don’t even do a credit pull. 

The point is, you have financing options. Your debt-to-equity ratio is an important factor, and you should pay attention to it. But don’t let it become an albatross around your neck. By carefully reviewing the various loans on the market, you should be able to find one that matches your needs and qualifications.