When you're weighing up an investment, it helps to understand how a business manages its money. You might look at profits, revenue or growth. But behind the scenes, how a company is funded can affect its ability to operate, grow and stay afloat when times get tough.

One ratio investors turn to is the debt-to-equity ratio. It's a way of checking how much a business leans on borrowed money versus its own funding. But this isn’t about finding a “right” number. Different industries have different norms. And what looks risky in one sector might be common in another.

This article explores what the debt-to-equity ratio can (and can’t) tell you. We’ll break down how it works, why it matters, and how it fits into a broader picture of financial health. Because if you're going to invest, it's worth knowing what you're really investing in.

What is the debt-to-equity ratio?

The debt-to-equity ratio compares how much a business owes with how much it owns outright. In other words, it shows how much debt a company has relative to its equity —the money from its owners or shareholders.

It’s a leverage ratio, which means it helps you understand how much the business depends on borrowed funds. A higher ratio suggests the company relies more on debt to run or grow its operations. A lower ratio suggests it’s using more of its own money.

For a fictional example, let’s say you’re comparing two small businesses. The first is fully funded by its owner. No loans, no credit, just personal savings. The second uses a mix of personal funds and bank loans. It borrowed to buy stock, equipment and set up operations.

They might both be profitable. But their debt-to-equity ratios would look different because their funding sources are different. This ratio can help you spot those differences. It gives insight into how a company is structured financially — and how much risk it might be carrying.

How is the debt-to-equity ratio calculated?

To understand the debt-to-equity ratio, it helps to see how it’s calculated. The formula is:

Debt-to-equity ratio = Total debt ÷ Shareholder equity

• Total debt includes all the money a business owes. This usually covers short-term debt (like bills due within a year) and long-term debt (like loans that take years to repay).
• Shareholder equity is what’s left if a business sells all its assets and pays off all its debts. It represents the owners’ or shareholders’ stake in the business. This is also known as total shareholders’ equity.

Here’s a simple example.

Imagine a company with $300,000 in total debt and $600,000 in shareholders’ equity. Using the equity ratio formula, the calculation would be:

Debt-to-equity ratio = 300,000 ÷ 600,000 = 0.5

That means for every dollar of equity, the business has 50 cents of debt.

You can apply this same formula to any company with publicly available financial statements . Many investors calculate it when comparing businesses across the same sector.

Why does this ratio matter to investors?

The debt-to-equity ratio helps investors understand how a business funds itself and how exposed it might be to financial risk. This ratio can highlight:

• How much debt a company carries
• Whether it relies more on loans or owner funding
• How prepared it might be for tough economic conditions, like bear markets

A high debt-to-equity ratio doesn’t always mean trouble, but it does raise questions worth asking. It may signal that a business relies heavily on loans. That can make it more sensitive to interest rate changes .

It may also impact the company’s ability to fund future projects or meet regular debt payments. If the business faces a downturn or a drop in revenue, high capital debt can increase the pressure.

The debt-to-equity ratio might also hint at potential cash flow issues. If a company struggles to manage current debt or day-to-day expenses, its working capital position could be under strain.

While no ratio offers guarantees, this one gives early clues. It helps investors ask better questions, not make snap judgments.

How investors use this ratio in real life

The debt-to-equity ratio is one tool investors use to understand a company’s financial structure before making a decision. For long-term investors, it can offer insight into how a business balances risk and funding.

Some may prefer companies with lower debt levels. Others might accept a higher leverage ratio if they believe the growth potential is strong. This ratio can help shape a broader diversified portfolio approach, especially for investors looking to manage risk across different assets or sectors.

A simple example

Let’s say you’re comparing two Australian Securities Exchange-listed companies in the same industry:

• Company A has a debt-to-equity ratio of 0.3
• Company B has a debt-to-equity ratio of 1.5

Both are profitable. Both pay dividends . But they fund their operations differently. Company A uses mostly shareholder funds to grow. Company B relies more on loans and credit.

An investor might weigh this against other factors — like earnings, stability, and future outlook — before choosing. In that way, the debt-to-equity ratio doesn’t decide for you. It simply adds one more layer to your research.

What’s considered a 'good' or 'bad' debt-to-equity ratio?

There’s no universal benchmark for a “good” debt-to-equity ratio.

The average ratio can vary a lot depending on the industry. What looks like high debt in one business may be completely normal in another. That’s why it’s helpful to compare companies within the same sector rather than across unrelated industries.

Why industries differ

Some businesses, like banks and utilities, tend to carry more debt as part of their normal operations. Others, like tech companies or software firms, often rely more on shareholder funding and keep their debt levels low.

This is where understanding sector equity and industry trends helps.

Debt-to-equity ratio examples by industry

Here’s a general idea of what’s common across a few sectors :

• Banks and financials : Often have higher debt ratios — up to 2.0
• Utilities and infrastructure : Moderate to high ratios — 1.0 to 2.0
• Retail and manufacturing : Moderate levels — 0.5 to 1.5
• Technology : Often lower debt — 0.0 to 0.5

These numbers can change over time. They also depend on company size, strategy, and even where the business is in its growth cycle.

Instead of chasing a specific number, it can help to view the debt-to-equity ratio in context and compare it to industry averages.

When high debt might be strategic (and when it’s a red flag)

Not all debt is bad . Some businesses use it to grow faster or take advantage of opportunities. When managed well, leverage can help a company expand operations, invest in assets, or enter new markets without diluting ownership. This is more common when interest rates are low and debt payments are manageable.

In these cases, a higher debt-to-equity ratio could reflect a deliberate growth strategy, not necessarily financial stress. But there are limits.

High leverage can become a problem if:

• Cash flow weakens
• Interest rates rise
• Revenue becomes unpredictable

Under pressure, companies may struggle to cover ongoing debt payments, especially if they lack a strong replacement margin — the ability to recover or maintain profits after costs. This can restrict future borrowing, reduce flexibility, or even force cost-cutting.

So, while high debt can drive returns in the right conditions, it can also raise the stakes.

What doesn’t the debt-to-equity ratio tell you?

The debt-to-equity ratio is useful, but it doesn’t cover everything. Here are some ways it falls short:

• I t won’t tell you how innovative a business is, how loyal its customers are, or how strong its brand might be.
• It also doesn't measure growth potential, profitability, or how well a company handles competition.
• A ccounting methods can also influence the result. Some companies include preferred shares in their equity calculations, while others don’t.
• The value of intangible assets, like patents or software, can also affect the ratio depending on how they’re reported.

Though the ratio gives insight into a company’s financial structure, it leaves out many other important factors. As we’ve said, it’s best viewed as one part of a broader analysis, not a stand-alone verdict.

Debt-to-equity vs other ratios: what else should I look at?

The debt-to-equity ratio is a starting point, but it’s not enough on its own. To better understand a company’s financial position, investors often look at other leverage metrics alongside it. Here are a few common ones:

• Debt service ratio : This shows how easily a company can meet its loan repayments using its earnings. A higher ratio often signals stronger repayment ability.
• Operating profit : Also called operating income, this reflects a company’s profit related to its core operations — before interest and taxes. It helps assess whether regular business activity can support debt service costs.
• Debt schedule : This is a breakdown of when each portion of debt is due. It’s helpful for understanding whether repayments are spaced out or heavily weighted in certain years.

Each of these measures looks at a different part of the picture. When used together, they help you better assess a company’s financial strength and risk level.

Making sense of debt and equity in investing

The debt-to-equity ratio offers a simple way to see how a company funds itself — and whether it leans more on borrowing or ownership. Once you know how to calculate the ratio, you can apply it to any company with public financials.

On its own, the debt-to-equity ratio won’t give you the full picture. But used with other numbers and a bit of curiosity, it can help you understand what’s going on behind the scenes before you decide to get involved.