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What is the debt to equity ratio and why should you care?

What Is The Debt To Equity Ratio And Why Should You Care?

Let’s start at the beginning. What is a balance sheet?

Even the most confident and experienced business owners stumble when we talk about the balance sheet.

Don’t over think it: A balance sheet is a statement of assets, liabilities, and equity as of any given date. Typically, a balance sheet is prepared monthly, quarterly, or often times annually depending on the size of the business.

A balance sheet has two faces and gives an insight into the health of the business:

  • The assets of the company.
  • The liabilities and owner equity.

What is debt to equity ratio?

Simply put, the debt to equity ratio (D/E) compares a company’s total debt to total equity. It is calculated as follows: D/E ratio = Total Liabilities/Shareholders Equity. It is a measurement of whether the company can cover its debt and an indication of how leveraged the company is. The higher the ratio, the more difficult it may be for the business to cover all its liabilities.

What is a good debt to equity ratio?

This ratio can vary by industry and some industries tend to use more debt financing than others. A small business owner with a team working remotely and little to no loans or leases will look a lot different than a small manufacturing company with equipment leases, lines of credit, and other assorted liabilities.

The calculation for the debt to equity ratio details for the business owner how leveraged the business is and how it may affect the company’s bankability. Banks and other financial institutions may view a higher debt to equity ratio as risky because it shows that the owners/principles haven’t funded the business as much as creditors have. In other words, have you leveraged the business to grow?

Read more from our previous post in April 2018, What is a debit to equity ratio and why do I need to understand it?

Ok, I need some help understanding this!

At Expex, we offer bookkeeping services to help you understand the health of your business and can assist you with the calculations as well as critical decisions to manage the ratio.

No worries, it sounds a bit scary and overwhelming but the debt to equity ratio can be a simple window in the health of your business.  Need more help, contact us, we’ll show you how it’s done.

I need to hire Carly!

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