What is the Debt-to-Equity Ratio? How to Assess Company Financing

The Debt-to-Equity Ratio is a key financial metric that shows how much debt a company has in relation to its equity. This figure is used to assess a company's financing structure and how vulnerable the business might be to weaker earnings or higher interest rates.

Formula for the Debt-to-Equity Ratio

The most common formula is:

Debt-to-Equity Ratio = Total Debt / Equity

If a company has NOK 6 million (approximately £450,000 / $550,000) in debt and NOK 3 million (approximately £225,000 / $275,000) in equity, its debt-to-equity ratio is 2. This means the company has two krone in debt for every krone in book value equity.

What is a Good Debt-to-Equity Ratio?

There is no universal benchmark. A low debt-to-equity ratio typically means that a larger proportion of assets are financed by equity. This can provide better resilience. A high debt-to-equity ratio signifies greater reliance on debt financing and can increase risk, especially if revenues are volatile or interest rates rise.

The industry plays a significant role. Real estate companies and capital-intensive businesses often have more debt than, for example, consulting firms. Therefore, compare the ratio with relevant competitors and the company's own historical performance.

When Can the Figure Be Misleading?

With very low equity, the debt-to-equity ratio can become extremely high. In the case of negative equity, the key figure loses much of its usual meaning, and the situation should be investigated further. Book values can also differ from market values. For instance, an older building might have a different real value than its book value.

The debt-to-equity ratio alone does not indicate whether a company can pay its bills. Combine it with liquidity ratios, cash flow, interest expenses, and profitability. Also, check whether the debt is short-term or long-term.

How to Use the Debt-to-Equity Ratio for Supplier Selection

First, observe the trend. A rapid increase without a corresponding growth in profitability can be a warning sign. Then, investigate whether the business has stable cash flow and sufficient equity. For larger contracts, this key figure should be part of a broader financial assessment, not the sole basis for decision-making.

Debt-to-Equity Ratio on Proffi

Proffi can calculate the debt-to-equity ratio from reported total debt and equity and show the development year by year. Always state which accounting year the calculation applies to, the data source, and the formula. Missing or negative equity should be clearly explained rather than presented as a normal ratio.