What is the debt-to-equity ratio?
The debt-to-equity ratio tells you how many euros of debt and provisions there are for every euro of equity. A ratio of 2 means: for every euro from the owners, there are two euros from others.
Debt is not bad in itself. A loan to buy an oven or a building can make a company grow faster than with its own money alone. But debt has to be repaid, even in a bad year. The higher the ratio, the smaller the margin for setbacks.
Calculate the debt-to-equity ratio: the formula
Debt-to-equity = (balance sheet total − equity) ÷ equity
Balance sheet total: item 20/58. Equity: item 10/15. The difference is liabilities: provisions (16) and debt (17/49).
Banks sometimes only count financial debt (loans), without suppliers and taxes. That ratio comes out lower. Nummo counts all debt and provisions, as above.
Example: Bakkerij De Zoete Korst
- Step 1
Calculate liabilities
The fictitious bakery has a balance sheet total of €500,000 and equity of €200,000. The rest is debt: €150,000 long term and €150,000 short term.
€500,000 − €200,000 = €300,000 - Step 2
Divide by equity
For every euro of equity, the bakery has 1.50 euros of debt.
€300,000 ÷ €200,000 = 1.50
- < 1.00low: more equity than debt
- 1.00 – 3.00average
- ≥ 3.00high: heavily funded by others
What is a normal debt-to-equity ratio?
Rules of thumb Nummo uses: below 1 the company has more equity than debt, between 1 and 3 is average, above 3 it is heavily funded with outside money.
Here too it differs by sector. Real estate companies and wholesalers naturally work with more debt, consultancies and software companies with less. A high ratio is mainly a risk if the company earns little to repay the debt: so also look at EBITDA and cash flow.
Debt-to-equity and solvency
Debt-to-equity is the flip side of the solvency ratio. Both use the same figures: the bakery has a solvency ratio of 40% and a debt-to-equity ratio of 1.50. When solvency rises, debt-to-equity falls.
| Solvency ratio | Debt-to-equity | Meaning |
|---|---|---|
| 50% | 1.00 | as much equity as debt |
| 40% | 1.50 | like the bakery |
| 25% | 3.00 | three euros of debt per euro of equity |
| 10% | 9.00 | very thin buffer |
At Bakkerij De Zoete Korst, debt-to-equity fell in five years from 2.74 to 1.50, because profits stayed in the business.
- rule of thumb 3.00
Calculate it yourself
To calculate the debt-to-equity ratio for another company, enter the figures from its annual accounts. The item numbers follow the Belgian format, which builds on the European Accounting Directive.
- Solvency ratio40%