We have come to the last posting that has covered the 5 financial ratios contained in our FREE Business Health Check designed to give SME businesses and starting point for understanding how their business can do more. As a reminder, financial performance and results will be different between industries, markets and companies. The information contained in these blog postings are general in nature and are meant to be a guideline that can be used to help an SME business do more.
A Debt to Equity Ratio is simply:
Debt to Equity = Total Debt / Total Equity
Equity in a business can include:
– retained earnings
– paid in capital
– common or preferred (i.e. sale of shares to investors)
In our experience, most SME businesses do not know their Debt to Equity Ratio because they tend to run their business in such a way that bills and employees get paid and at the end of the year hopefully they are able to pay themselves something. A Debt to Equity ratio that is greater than 3 can mean that a business has not figured our how to generate value from the product or service that it offers to the market.
Banks and lenders look for a Debt to Equity Ratio that does not exceed 3 meaning that for every $1 of equity in the business there is less than $3 of debt. Keeping in mind that this is a general rule of thumb an SME business should take note of their Debt to Equity ratio and build a plan for keeping it below 3 which would mean they are building value from the product or service they provide to the marketplace.
That wraps up the 5 financial ratios contained in our FREE Business Health Check that we offer to SME businesses to help them do more. We would encourage you to take a look at your financial statements and see how your business is doing. The ability to understand the:
– Quick Ratio
– Current Ratio
– Debt Ratio
– Debt Service Ratio
– Debt to Equity Ratio
for your business can lead to opportunities for improvement and the ability for your business to do more.