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.