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Debt-to-Equity Ratio

Definition: A measure of the extent to which a firm's capital is provided by owners or lenders, calculated by dividing debt by equity. Also, a measure of a company's ability to repay its obligations. If ratios are increasing--more debt in relation to equity--the company is being financed by creditors rather than by internal positive cash flow which may be a dangerous trend.

When examining the health of your business, it's critical to take a long, hard look at your debt-to-equity ratio. If your ratios are increasing--meaning there's more debt in relation to equity--your company is being financed by creditors rather than by internal positive cash flow, which may be a dangerous trend.

You can avoid growing yourself out of business by sticking to your affordable growth rate. Your affordable growth rate is tied to your firm's assets. The basic idea is that your sales shouldn't grow more quickly than your assets. As a rule, this means if your sales double, your assets--including inventory, receivables and fixed assets--should also double. Assets are important because your lender may be unwilling to loan you any more money if your debt-to-equity ratio exceeds a certain figure. If sales and assets grow at the same rate, your debt-to-equity ratio should remain within the lender's limit, allowing you to borrow to finance growth forever.

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