Debt-to-equity

Debt means borrowings: long-term and short-term loans, bonds and debentures, including the part due within a year. Trade payables and other operating liabilities are not debt, which is why total liabilities is the wrong numerator. Equity is the shareholders' funds on the balance sheet: share capital plus reserves.

How to read it

Commerce textbooks often teach that a D/E of 2:1 is ideal, because borrowing boosts shareholders' returns. The investor's view is different: the ideal D/E is zero. The reason is asymmetry. Shareholders are paid only if there is a profit, but interest must be paid whether there is a profit or a loss. When an industry slowdown brings two or three years of losses and there is no money left for interest, the company sinks. Many good businesses have been destroyed this way. A D/E above 1 means the company owes lenders more than its shareholders have put in.

Net debt to equity

Some analysts subtract cash and liquid investments from debt first. This gives a fairer picture for a company that has borrowed but holds large cash balances. For how many years of operating profit the debt would take to repay, use net debt to EBITDA.

Where D/E does not apply

Never use D/E for banks, NBFCs or any lending business. Borrowing from the public through current accounts, savings accounts and fixed deposits, and lending that money on, is their business model. For them, look at the CASA ratio, cost of funds and net interest income instead.

Read it with interest coverage

A low D/E is not enough on its own. A company can borrow little and still be unsafe if it earns little or no operating profit. Interest coverage checks whether profit can pay the interest.

Where to find it

Take borrowings from the balance sheet, both non-current and current, and divide by total equity. Most research platforms show D/E directly; the D/E formula page explains how to read it.

Common mistakes

• Using total liabilities instead of debt, which treats suppliers as lenders.
• Comparing D/E across industries with very different needs for capital.
• Ignoring a shrinking equity base. Losses or large buybacks reduce equity and can push D/E up, or make it meaningless, even when debt has not changed.

Questions investors ask

What is a good debt to equity ratio? From an investor's point of view, as close to zero as the business allows. Above 1 deserves a careful look at interest coverage and cash flow.

Is a negative D/E possible? Only when equity is negative, after years of losses. It signals deep trouble, not low debt.