If you own a business, taking on some debt is often part of running and growing it. According to the Federal Reserve’s Small Business Credit Survey, about two in three small businesses carry debt. Used strategically, debt can help manage cash flow, finance equipment purchases, or bridge gaps between invoicing and payments.
Still, too much debt can make it harder to keep up with expenses or maintain stability during slower periods. Understanding your business’s debt ratio can help you monitor financial health and make informed decisions about future borrowing.
What Is a Debt-to-Equity Ratio?
The debt-to-equity ratio (D/E ratio) measures how a business finances its operations—through borrowed money or the owner’s invested capital. It shows how much debt your company uses for every dollar of equity.
You can calculate it using this formula:
Debt-to-Equity Ratio = Total Liabilities ÷ Shareholder Equity
For example, if a business has $50,000 in debt and $150,000 in owner equity, its debt-to-equity ratio would be 0.33. This means the company has 33 cents of debt for every dollar invested by its owners.
A higher ratio indicates a company relies more on borrowed funds, while a lower ratio shows more reliance on equity. What counts as a “good” or “bad” ratio varies widely by industry, business size, and growth goals. Manufacturing firms, for example, may operate with higher ratios than service-based businesses, where operating costs are lower.
In general, comparing your ratio to industry averages—available through sources like the U.S. Census Bureau’s Annual Business Survey or ReadyRatios Industry Standards—can help you see how your company’s financial structure stacks up against peers.
How Businesses Use Debt Effectively
Debt isn’t always a sign of financial trouble. In many cases, borrowing can help a business grow, operate more efficiently, or preserve ownership control. The key is using debt strategically and understanding the terms behind it.
Maintaining Control and Flexibility
When you finance your company with debt instead of selling equity, you keep full ownership of your business. That means you don’t have to share profits or decision-making authority with outside investors.
For many small business owners, this independence is worth the cost of borrowing—especially if the funds are used for projects that increase revenue or productivity.
Taking Advantage of Tax Benefits
In certain cases, interest payments on business loans may be tax-deductible. The Internal Revenue Service (IRS) allows companies to deduct “ordinary and necessary” business expenses, including interest on qualifying business loans. This can lower your taxable income, reducing the overall cost of financing.
However, tax laws are complex, so it’s best to consult a qualified tax professional before making decisions based on potential deductions.
Using Debt as a Growth Tool
Many companies borrow to invest in equipment, technology, or inventory that can help them meet customer demand. Access to financing can also provide the flexibility to respond to market changes or unexpected expenses without disrupting operations.
Small businesses have several options for financing, ranging from traditional bank loans and Small Business Administration (SBA) loans to newer forms of online lending. The right choice depends on your company’s size, cash flow, and credit profile.
When used responsibly, debt can help your business operate more smoothly and seize opportunities that might otherwise be out of reach. The challenge is knowing when additional borrowing starts to carry more risk than reward—a topic explored in the next section.
When Debt Becomes a Risk
Debt can strengthen a business, but it can also create pressure if not managed carefully. A high level of debt may reduce flexibility, limit cash flow, and increase the impact of economic slowdowns. Understanding these risks helps business owners plan ahead and make more informed financial decisions.
Cash Flow Challenges
When a company has large monthly loan payments, a slowdown in sales or late customer payments can make it difficult to keep up with expenses. Consistently reviewing cash flow statements can help you identify early signs of strain before they become serious problems.
Higher Interest Costs
Borrowing too much, or taking on debt with high interest rates, can eat into profits over time. If rates rise, businesses that rely on variable-rate loans may face higher payments, which can quickly affect margins. Using financial tools or working with a qualified accountant can help you evaluate whether refinancing or consolidating debt could lower costs.
Industry and Market Factors
Some industries naturally operate with higher debt levels because of their structure or capital needs. For example, manufacturers and construction companies often take on more debt than service-based firms. That’s why it’s important to compare your financial ratios with those typical in your field.
Credit and Reputation Impacts
Falling behind on payments or defaulting on a loan can harm your company’s credit history. This may make it harder or more expensive to borrow in the future.
Lenders may report business credit information to credit bureaus, including when loan accounts become delinquent, which can affect credit evaluation for both businesses and their owners. Staying on top of payment schedules—and addressing potential shortfalls early—can help preserve your access to capital when you need it most.
Finding the Right Balance
Managing debt isn’t about avoiding it altogether—it’s about keeping it in proportion to your company’s goals and capacity. A healthy debt level gives your business the flexibility to invest in opportunities while maintaining enough stability to weather slow periods.
Track Key Financial Ratios Regularly
Your debt-to-equity ratio is one indicator of your financial structure, but it’s only one piece of the puzzle. Reviewing related metrics—such as your debt-to-asset ratio and current ratio—can help you understand how much risk your business is taking on.
The debt-to-asset ratio measures how much of your business is financed by debt versus owned assets. Ideal ratios vary by lender but may range from 0.3% to 0.6%. The lower the ratio, the less financial risk your company carries.
Tracking these ratios over time also helps you spot trends. If your debt levels are rising faster than your revenue or assets, it may be time to review spending, renegotiate payment terms, or slow new borrowing.
Benchmark Against Your Industry
There’s no single “right” ratio for every business. What’s considered a healthy balance in one industry might be unsustainable in another. Reviewing publicly available data from the U.S. Census Bureau’s Annual Business Survey or the ReadyRatios Industry Standards database can provide helpful context.
Consult a Financial Professional
Financial decisions carry unique implications for every business. Working with a trusted accountant, business advisor, or financial planner can help you interpret your ratios and make borrowing decisions that fit your long-term goals. Professionals can also assist with scenario planning—estimating how changes in sales, expenses, or interest rates could affect your ability to manage debt.
Building Long-Term Financial Health
Debt is neither good nor bad on its own—it’s a tool. The key is knowing how to use it in a way that supports your business’s goals without stretching resources too thin. By tracking your debt ratios, comparing them to reliable industry data, and reviewing them regularly with a financial professional, you can stay aware of how debt is affecting your company’s stability and growth potential.
