Debt-to-equity ratio
The debt-to-equity ratio compares a company’s total debts (liabilities) with its total shareholders’ equity. BDC says it is primarily used to assess a company’s ability to raise funds through new debt.
The debt-to-equity ratio shows how much a business is using debt to finance itself relative to equity. BDC says it is calculated by dividing total liabilities by total shareholders’ equity, and that a business primarily financed by debt has a high ratio. A buyer may meet it when a lender reviews the business, or the buyer’s own company, before lending.
How lenders read it
BDC says bankers use the ratio to see how assets are financed, whether by creditors or the owner’s own investment. It adds that, to assess financial risk, the lending institution compares the ratio with that of other businesses in the same sector, and that a highly leveraged company may be unable to repay its debts if revenues decline. An acquisition loan can change the ratio, because it adds to liabilities.
What to ask
- Whether the lender will test the ratio before or after the acquisition debt is added
- Whether vendor take-back debt is counted as a liability
- Whether the ratio is a covenant, and where the line sits
Lenders also look at fixed charge coverage. See how to finance a business acquisition in Canada.
Sources
This definition is checked against primary sources. Links were last confirmed on the dates shown.
- 01Business Development Bank of CanadaGovernmentWhat is a debt-to-equity ratio?
- 02Business Development Bank of CanadaGovernment4 types of financial ratios to assess your business performance
- 03Business Development Bank of CanadaGovernmentHow much can I borrow for my business?
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