Guide to healthy debt-to-equity ratio for small businesses

Debt doesn’t have to be a bad thing in business, especially if you’re borrowing to grow. Used well, it can fuel that growth, open up new opportunities and help you manage cash flow through quieter periods.

But understanding how much debt is too much - and how to measure it - is just as important as the decision to borrow in the first place. That's where the debt-to-equity ratio comes in. Here's what it means, how to calculate yours and what it can tell you about the financial health of your business.

What is debt to equity?

The debt-to-equity ratio (often written as D/E ratio) compares how much a business owes to how much its owners have actually invested in it. It's a measure of financial leverage - showing how reliant the business is on borrowed money relative to its own capital base.

A higher ratio means a business is carrying more debt relative to equity. A lower ratio suggests it's more self-funded. Neither is automatically good or bad as context is key. A capital-intensive business in manufacturing may comfortably carry a higher ratio than a service business with lower overheads, for example,

Understanding the difference between equity vs debt financing is a useful starting point before exploring your own ratio.

Calculating your debt-to-equity ratio

The formula is pretty straightforward:

Debt-to-equity ratio = Total liabilities ÷ Shareholders' equity

Total liabilities covers everything the business owes - short-term debts, long-term loans, outstanding supplier payments and any other financial obligations. Shareholders' equity is the value of the business that belongs to its owners: assets minus liabilities, or the total investment made into the business plus any retained earnings.

So if your business has £200,000 in total liabilities and £100,000 in shareholders' equity, your debt-to-equity ratio is 2.0. That means for every £1 of equity, you're carrying £2 of debt.

You'll find both figures on your balance sheet. Total liabilities cover everything you owe — loans, overdrafts, supplier credit, tax bills. Shareholders' equity is what's left after liabilities are subtracted from total assets.

What is a healthy debt-to-equity ratio?

As a general guide, a ratio between 1.0 and 2.0 is typically considered manageable for most small businesses. It signals that debt is being used to support growth without becoming a burden.

A ratio below 1.0 suggests the business is largely self-funded, which can indicate financial stability, though it might also mean you're not making the most of available finance to grow.

A ratio above 2.0 doesn't automatically mean trouble, but it does warrant a closer look. It means a significant portion of the business is leveraged, and lenders may view it as higher risk when assessing applications for new finance. This depends heavily on industry norms and the nature of the debt.

Industry matters too. Capital-intensive sectors like manufacturing or construction typically carry higher ratios than service businesses, which need fewer physical assets to operate. Always compare your ratio against similar businesses rather than a one-size-fits-all benchmark.

The advantages and disadvantages of equity financing are also worth weighing if you're considering your options for reducing your D/E ratio.

How does debt-to-equity ratio impact your business?

Your D/E ratio influences more than just how your accounts look. It shapes how others see you too. Here’s what to keep in mind when it comes to D/E ratio:

• Access to finance. Lenders look at your D/E ratio as one indicator of risk. A high ratio may make it harder to secure additional borrowing, or result in higher interest rates, because it suggests the business is already significantly leveraged.

• Investor confidence. If you're seeking investment, a high D/E ratio can make potential investors cautious. It suggests that a larger portion of any future profits may go towards servicing debt rather than growing the business or delivering returns.

• Financial resilience. Businesses with lower D/E ratios tend to be better placed to weather downturns. When income dips, debt repayments remain fixed -- and a high debt burden can put real pressure on cash flow.

• Growth potential. Paradoxically, a very low D/E ratio might also raise questions about whether a business is being too cautious. Sensible leverage can accelerate business growth that would be impossible through retained earnings alone

If you're exploring your finance options, help your business go further with business finance that backs you at Funding Circle.

07/05/26: While we want to help as much as we can, the information found here is provided solely for informational purposes and should not be considered financial or legal advice. To the extent permitted by law, Funding Circle does not accept any liability for any loss or damage which may arise directly or indirectly from the use of, or reliance on, the information contained here. If you have any questions, please speak to your professional adviser or seek independent legal advice.