What level of debt is healthy for a business?

Taking on too much debt can make you less flexible and expose you to risk if revenues fall or interest rates rise.

Exactly what level of debt is suitable for your business depends on your precise requirements at any one time.

There is a healthy level of debt, or ‘gearing’, that enables a business to grow and capture market share.

It’s not an exact science, however, and what’s regarded as healthy will also differ from industry to industry. For example, capital-intensive industries such as manufacturing commonly have higher levels of debt than, say, a tech company that operates online.

The debt-to-equity ratio is a simple formula to show how capital has been raised to run a business. It’s considered an important financial metric because it indicates (a) how financially stable a company is when facing problems with trading or other operational considerations and (b) what ability it has to raise additional capital for growth.

A company’s debt-to-equity ratio is commonly seen as a measure of its stability. The ratio measures the level of debt the company takes on to finance its operations, against the level of capital, or equity, that’s available.

It’s calculated by dividing a business’ total liabilities by the total amount of shareholders’ equity. Shareholders’ equity represents the company’s net worth – that is, the amount shareholders would receive if the company's total assets were liquidated and all of its debts repaid.

It might also be calculated by subtracting the company’s total liabilities from its total assets, both of which are itemised on the company's balance sheet.

The resulting figure shows how much the company relies on debt. A higher ratio suggests that it is more dependent on funding from outside the business, and therefore potentially less stable if it were to encounter problems with trading or other factors relating to how it operates.

Generally, a good debt-to-equity ratio is around 1 to 1.5. However, the ideal debt-to-equity ratio will vary depending on the industry, as some industries use more debt financing than others. Capital-intensive industries like the financial and manufacturing industries often have higher ratios that can be greater than 2.

A high debt-to-equity ratio indicates a business using debt to finance its growth. Companies that invest large amounts of money in assets and operations (capital-intensive companies) often have a higher debt-to-equity ratio. For lenders and investors, a high ratio means a riskier investment because the business might not be able to make enough money to repay its debts.

If a debt-to-equity ratio is lower – closer to zero – this often means the business hasn't relied on borrowing to finance operations. Investors can be unwilling to invest in a company with a very low ratio, as it suggests the business isn't realising the potential profit or value it could gain by borrowing and increasing the scale of its operations.

When deciding what level of debt is suitable for your business, you should consider whether you'll be able to service that debt in the future.

Determining whether your level of debt is healthy means asking questions like the following:

  • Do you operate in an industry that naturally requires a high level of debt to function effectively and keep up with competitors?
  • How does the result of your debt ratio analysis compare with companies of a similar set-up in your sector?
  • Have you provided a personal guarantee for any of the business’ borrowing?
  • Is your market likely to decline in the near future?
  • Could a rise in interest rates affect your ability to service the debt?

Be aware that providing personal guarantees for business borrowing is common, but it can put you at risk of personal liability should the company get into difficulty.

If you’re having problems dealing with debt, there may be some measures you can take. Find out more on our Dealing with debt page.

You might also consider debt consolidation and refinancing as possible ways to reduce your monthly repayments.

Even if you don’t have any immediate issues, you should make sure your business has sufficient working capital to cope with tougher trading conditions.

Harvard Business Review – A refresher on debt-to-equity ratio Link opens in a new window

This article provides a detailed explanation of why the debt-to-equity ratio is so important.

PwC – Improving working capital Link opens in a new window

Read PwC's analysis on working capital and learn how those businesses that manage it well have a competitive advantage over businesses that don’t.

Business Debtline Link opens in a new window

A charity that gives businesses free and independent advice on dealing with debt.

Step Change – debt charity Link opens in a new window

Debt advice for self-employed people and sole traders.

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Reference to any organisation, business and event on this page does not constitute an endorsement or recommendation from the British Business Bank or the UK Government. Whilst we make reasonable efforts to keep the information on this page up to date, we do not guarantee or warrant (implied or otherwise) that it is current, accurate or complete. The information is intended for general information purposes only and does not take into account your personal situation, nor does it constitute legal, financial, tax or other professional advice. You should always consider whether the information is applicable to your particular circumstances and, where appropriate, seek professional or specialist advice or support.