Debt-to-Equity Ratio Explained

The formula
Sample computation

The debt-to-equity ratio tells you how much of your business is financed by creditors compared with how much is financed by the owners. You divide total liabilities by total equity, both taken from the balance sheet. A ratio of 0.5 means $0.50 of liabilities for every $1.00 of equity, and a ratio of 2.0 means $2.00 of liabilities for every $1.00 of equity.

The open textbook Principles of Finance 2e from OpenStax says the ratio "shows the relationship between debt and equity as it relates to business financing" (OpenStax, section 6.4, opened October 29, 2026).

The formula

Principles of Finance 2e gives the formula as:

Debt-to-Equity Ratio = Total Liabilities ÷ Total Stockholder Equity

OpenStax's Principles of Accounting, Volume 1 states the same formula as "Debt-to-equity ratio equals total liabilities divided by total stockholder equity" (OpenStax, Appendix A, opened October 29, 2026). For a business that isn't a corporation, use the owner's equity line on your balance sheet in place of stockholder equity.

Both inputs come from the balance sheet on the same date. Total liabilities include everything the business owes, not only loans: accounts payable, credit card balances and accrued expenses count too.

Sample computation

This is a sample with invented figures for a fictional business, Harbor Street Bakery, on December 31.

Liabilities

Bank loan: $60,000.00
Accounts payable to suppliers: $9,000.00
Business credit card balance: $3,000.00
Wages owed but not yet paid: $12,000.00
Total liabilities: $60,000.00 + $9,000.00 + $3,000.00 + $12,000.00 = $84,000.00

Equity

Total owner's equity: $120,000.00

Ratio

Debt-to-equity ratio = $84,000.00 ÷ $120,000.00 = 0.70, also written 0.7:1.
That's $0.70 of liabilities for every $1.00 of equity.

As a check, total assets on the same balance sheet would be $84,000.00 + $120,000.00 = $204,000.00, because assets equal liabilities plus equity.

How to read the ratio

OpenStax's textbooks describe the ratio this way, without setting a cut-off:

Introduction to Business 2e says: "In general, the lower the ratio, the better. But it is important to assess the debt-to-equity ratio against both past values and industry averages." It adds: "A ratio above 100 percent means the firm has more debt than equity. In such a case, the lenders are providing more financing than the owners" (OpenStax, section 14.7, opened October 29, 2026).
Principles of Accounting, Volume 1 says: "It is less risky and less costly to use equity sources for financing as compared to debt resources. This is mainly due to interest expense repayment that a loan carries as opposed to equity, which does not have this requirement."

So compare your ratio with your own past ratios and with businesses like yours, and read it alongside your cash flow and your ability to pay interest. If your loan agreement mentions this ratio, ask your accountant or lender how it's calculated there.

Debt-to-equity ratio and debt ratio

The debt ratio divides total liabilities by total assets instead of by equity. Principles of Finance 2e says: "Both the debt-to-assets and debt-to-equity ratio have total liabilities in the numerator. The difference in the two ratios is the denominator."

What changes the ratio

Because the ratio is liabilities divided by equity, it goes down when liabilities fall or equity rises, and up when liabilities rise or equity falls. For example:

Paying down a loan reduces liabilities.
Taking on a new loan or a larger card balance increases liabilities.
Profits kept in the business add to equity, and owner withdrawals reduce it.

If equity is zero or negative, dividing by it doesn't give a meaningful ratio; talk to your accountant.

Frequently Asked Questions

What's the debt-to-equity ratio formula?

OpenStax's Principles of Finance 2e gives the same formula: total liabilities over total stockholder equity. For a business that isn't a corporation, use total owner's equity. Take both figures from the balance sheet on the same date.

What does a 2.0 debt-to-equity ratio mean?

It means the business has $2.00 of liabilities for every $1.00 of equity. OpenStax's Introduction to Business 2e says "A ratio above 100 percent means the firm has more debt than equity. In such a case, the lenders are providing more financing than the owners."

What is a good debt-to-equity ratio?

The OpenStax textbooks cited on this page don't give a single number. Introduction to Business 2e says: "In general, the lower the ratio, the better. But it is important to assess the debt-to-equity ratio against both past values and industry averages." If your loan agreement mentions the ratio, check how it's defined there.

Does the debt-to-equity ratio include accounts payable?

Using total liabilities, as the OpenStax formula does, includes accounts payable and every other liability on the balance sheet. If a lender or loan agreement uses the ratio, ask how it's calculated there.

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