Quick answer
The debt-to-equity ratio measures how much of a business is funded by what it owes compared with what the owners have put in or left in. Divide total liabilities (or, for some lenders, interest-bearing debt only) by owners' equity from the balance sheet. A ratio of 1.0 means debt and equity are equal. The higher it climbs, the more a lender worries about the business absorbing a bad year.
Key points
- Debt-to-equity = liabilities ÷ owners' equity, both taken from the balance sheet
- Lenders often remove goodwill and money owed by related parties before calculating equity
- A director loan that's formally subordinated can be treated more like equity than debt
- Negative equity doesn't automatically rule out finance, but it changes which lenders will look
Every business is paid for by two kinds of money: money it owes and money that belongs to its owners. The debt-to-equity ratio sets those two side by side. It’s a snapshot of how stretched the balance sheet is, and it tells a lender how much cushion stands between a rough patch and a loss on its loan.
Where the debt service coverage ratio looks at cash flow over a year, debt-to-equity looks at a single date. Lenders usually check both.
The formula, and the two versions of it
The broad version divides total liabilities by owners’ equity. Total liabilities include loans, but also trade creditors, GST and PAYG owing, employee leave provisions and anything else the business owes. Equity is what’s left when liabilities are subtracted from assets: share capital, retained profits and, for a trust, any accumulated funds.
A narrower version uses only interest-bearing debt, which leaves out supplier accounts and tax provisions. Its result is lower, so when a lender quotes a limit, ask which version it means.
What lenders change before they calculate it
The raw figure from your accounts is rarely the one a credit assessor ends up with. Three adjustments come up again and again in Australian small business files.
| Balance sheet item | Usual lender treatment | Effect on the ratio |
|---|---|---|
| Goodwill and other intangibles | Removed from equity, leaving tangible net worth | Ratio rises |
| Loans to directors or related entities (often Division 7A loans) | Removed from assets because they may never be repaid | Ratio rises |
| Loans from directors, signed away behind the lender | Moved from debt towards equity | Ratio falls |
Trusts carry a fourth quirk. Profits distributed to beneficiaries but not yet paid, known as unpaid present entitlements, often sit as liabilities. A lender may be willing to look through them if the beneficiaries are the same people guaranteeing the loan.
Worked example: a fit-out company in Perth
A shopfitting company’s balance sheet shows total liabilities of $900,000, including a $300,000 loan from its director. Equity is $400,000, of which $150,000 is goodwill from buying out a former partner.
- Straight from the accounts: $900,000 ÷ $400,000 = 2.25
- If the director’s loan is subordinated by deed, it moves to the equity side: liabilities $600,000, equity $700,000
- Goodwill comes out of that equity: $700,000 − $150,000 = $550,000
- Lender’s adjusted figure: $600,000 ÷ $550,000 = 1.09
The business didn’t change; the way its balance sheet was presented did. That’s why it pays to talk to your accountant about a subordination deed before an application goes in, not after a decline.
Weighing up whether your balance sheet can carry more debt? Get a specialist’s read on it before you apply anywhere.
When does a high ratio actually matter?
A high ratio matters most for unsecured lending and larger bank facilities, where the balance sheet is a big part of the decision. Banks often write a maximum gearing level into the contract as a covenant. Lenders secured by residential or commercial property weigh it less, because the property itself protects them.
If the ratio is high because the owners have been funding growth with borrowed money, the answer may be fresh capital rather than another loan. Our comparison of debt vs equity funding works through that choice, and mezzanine finance sits in the space between the two.
Turning a balance sheet into a borrowing plan
Your ratio is only one input. Cash flow, security and the purpose of the loan all count too. Give us the rough shape of your assets, your liabilities and the job the loan has to do, and we’ll tell you which kinds of lenders read a balance sheet like yours kindly. Filling in the form is roughly a one-minute job, your credit history stays untouched at this stage, and nothing gets circulated to lenders by the dozen. A specialist goes through it personally and rings to talk it over. Numbers that line up with your accounts get you to a workable option sooner.
Frequently asked questions
What is a good debt-to-equity ratio for a small business?
It depends heavily on the industry. A consulting firm with few assets usually runs low, while a transport or construction business that finances trucks and machinery normally sits higher. Lenders compare you with similar businesses and look at the trend over two or three years rather than one figure.
Is debt-to-equity the same as gearing?
They're close cousins. Gearing is often expressed as debt divided by debt plus equity, which gives a percentage, while debt-to-equity compares the two directly. Both describe how much a business relies on borrowed money.
Do director loans count as debt?
On the balance sheet, money a director has lent to the company is a liability. Many lenders will treat it as quasi-equity if the director signs a deed agreeing not to be repaid before the lender, which can improve the ratio considerably.
Can a business with negative equity get a loan?
Sometimes. Negative equity usually means past losses have exceeded the capital put in. Lenders that rely on property security or current cash flow, rather than the balance sheet, may still lend if trading has turned around and the security is solid.
Where do I find the figures?
In the balance sheet your accountant prepares with the annual tax return, or in up-to-date management accounts from your bookkeeping software. Total liabilities and total equity are usually shown as subtotals.