Debt ratio and debt-to-equity: measuring gearing without guesswork

Two views of the same balance sheet

The debt ratio is total liabilities divided by total assets: the share of the business funded by someone other than the owners. Debt-to-equity is total liabilities divided by shareholders equity: the same exposure expressed as a multiple of the owner stake.

How lenders read them

A debt ratio above 0.6 usually triggers questions about covenant headroom. Debt-to-equity above 2.0 means creditors have twice the stake owners do, which raises the cost of new borrowing. But both figures are context dependent: asset-backed businesses carry gearing comfortably, service businesses with thin balance sheets do not.

What to include

• All interest-bearing borrowing, including overdrafts and the current portion of loans.
• Lease liabilities recognised under the applicable standard.
• Trade payables, if you are measuring total liabilities rather than net debt. Say which you mean.
• Do not exclude related-party loans just because repayment is informal.

When gearing is good

Borrowing to fund assets that return more than the interest cost increases return on equity. The test is not the ratio alone but the ratio alongside interest cover: gearing of 2.0 with interest cover of 8 times is safer than gearing of 1.0 with cover of 1.5 times.

The data problem

Gearing ratios need a balance sheet. Bank statements alone show cash movement, not obligations. If liabilities have never been posted to the ledger, a debt ratio of zero means the data is absent, not that the business is debt free. Reporting it as healthy would be misleading.

NanoFora marks gearing ratios as not calculable and names the missing accounts rather than implying an unleveraged position. See interest cover and balance sheet explained.