Borrowed money
Term loans, working capital limits, debentures and, depending on the definition used, unsecured loans from directors, partners or promoters.
Net Worth & Solvency Glossary · Lending
Debt-to-Equity Ratio, Read From Certified Figures
noun · also "debt-equity ratio", "D/E", "gearing"; a ratio, so it has no unit
Definition
The debt-to-equity ratio compares what a business has borrowed with what its owners have put in and left in the business. It is total debt divided by owners' funds (equity), and it measures gearing: how much of the business is financed by lenders rather than owners.
A higher ratio means more borrowing for each rupee of owners' money.
The ratio in one fraction
Total debtborrowed money
Owners' funds (equity)for a company, its net worth
= Debt-to-equity ratio
The arithmetic is simple. The definitions are not: which loans count as debt, and what counts as equity, decide the number.
Two totals
01How the ratio is built from two balance sheet totals
Formula
Debt-to-equity ratio = total debt ÷ owners' funds
What the owners put in and left in
For a company: share capital, the securities premium and reserves built from profits, less accumulated losses. This is essentially its net worth. For a firm, they are the partners' capital accounts.
The arithmetic is simple. The definitions are not. Whether a promoter's loan counts as debt or as "quasi-equity" can move the ratio a long way. A ratio that does not state which definition was used is not really a ratio a reader can rely on.
The promoter loan
Is it formally subordinated to the bank's dues, and barred from repayment during the facility?
YesQuasi-equity
Many appraisers treat it as part of owners' funds: it cannot leave before the bank is paid.
OtherwiseDebt
It sits in the numerator with every other borrowing.
Some obligations sit outside the balance sheet, such as guarantees given for group companies and bills discounted with recourse. A simple ratio misses them, so a careful reader asks about them.
Scale and strain
02Why tender committees pair gearing with a certified net worth figure
Each covers the other's blind spot.
Net worth statesThe size of a business
What it is worth after everything it owes.
Gearing showsHow that size was built
Financed by lenders, or by the owners themselves.
Same worth, different position
A business worth a given amount that borrowed heavily to get there
one worth the same that borrowed nothing
A tender committee judging whether a bidder can carry a contract wants both the scale and the strain, and tender conditions often set a ceiling on gearing. Lenders write it into loan covenants, which the borrower must keep meeting after the loan is drawn.
Why tangible net worth is often asked for alongside it
Gearing worked out on equity inflated by goodwill flatters the borrower exactly where it matters.
The pairing can help the bidder too
A modest net worth with very low gearing shows capacity the headline figure understates.
A solvency certificate or a net worth certificate for a bank loan can state how director and partner loans were treated, so the ratio can be read correctly.
Reading the level
03Leverage levels Indian bankers treat as comfortable in manufacturing and services
One rule first
There is no single comfortable ratio. Bankers read gearing against the sector, and each lender's policy, and each tender, sets its own acceptable level.
Capital-intensive businesses
Manufacturing, for example, usually carries higher ratios, because its borrowing is backed by plant and stock.
Services businesses
Usually expected to carry less debt, because they borrow mainly against cash flow.
What draws attention is change
- A sharp move between years with no matching change in the business usually means a large new borrowing or a reclassified reserve, and it is worth explaining before the appraiser asks.
- A steady rise over several years reads worse than one high year after an acquisition.
Written by Subham Jhunjhunwala · Reviewed by CA Sundram Gupta
This entry describes Indian practice in general terms. The lender's or tender's own definition governs the ratio it applies.
Need help with a certificate that uses debt-to-equity ratio? See our Solvency Certificate.