Is Your Business Financially Healthy? The Debt-to-Equity Ratio Every MSME Owner Must Know
Is Your Business Financially Healthy? The Debt-to-Equity Ratio Every MSME Owner Must Know
Every time an MSME applies for a working capital limit or a term loan, a credit officer runs a small set of ratios against the financials. These ratios decide your eligibility for said loan. One of those crucial metrics related to your business’s financial health is the debt-to-equity ratio.
Also known as the D/E ratio, this metric calculates a business’s liabilities (funds and other debts) to its shareholders’ equity (own capital). It is very important to know and maintain a ratio of 1 to get approved for any loans.
Here’s how to calculate D/E in 10 minutes, what a safe number looks like in India, and what to do if yours is already in the danger zone.
What the Debt-to-Equity Ratio Tells You?
The Debt-to-Equity (D/E) ratio compares how much of your business is funded by borrowed money versus how much is funded by your own money. Its formula is:
Debt-to-Equity Ratio = Total Debt ÷ Total Equity (Net Worth)
- A ratio of more than 1.5 means (say 2) that for every ₹1 you have put into the business, you have borrowed ₹2. Your business is a financial risk.
- A ratio of 1 or below 1 (say 0.8) means you have borrowed less than you have invested. Your business is in good financial condition.
Lenders read it as a risk question: if this business hits a bad quarter, who absorbs the loss first? When equity is thick, the owner absorbs it. When debt is thick, the lender does. That is the entire logic behind the number.
How to Calculate the Debt-to-Equity Ratio?
You can use your balance sheet and the simple formula mentioned above to calculate the D/E ratio of your business:
Step 1: Add up total debt
Include in your calculation:
- Term loans and equipment loans
- Cash Credit (CC) and Overdraft (OD) outstanding
- Working capital demand loans
- Vehicle and machinery loans in the business name
- Unsecured business loans and NBFC borrowings
- Loans against property used for the business
- Credit card and BNPL balances used for business expenses
- Informal borrowings such as money from relatives, private financiers, or the market
Step 2: Find your equity (net worth)
Equity is capital introduced by the promoter, plus accumulated reserves and retained profits, minus accumulated losses and drawings. On a company balance sheet, it is share capital plus reserves and surplus.
Equity = Total Assets – Total Liabilities
For a proprietorship or partnership, it is the capital account balance.
Step 3: Divide Step 1 into Step 2
Here’s a practical example: Meera runs a garment unit in Ludhiana. Her:
- Term loan outstanding is ₹18 lakh,
- CC utilisation is ₹22 lakh,
- An unsecured NBFC loan is ₹9 lakh, and
- Borrowed ₹6 lakh privately.
Total debt = ₹55 lakh.
Her capital account plus retained earnings stands at ₹25 lakh.
D/E ratio: ₹55,00,000 ÷ ₹25,00,000 = 2.2
Meera has been telling herself the business is fine because EMIs are being paid on time. Her balance sheet says she is carrying more than twice as much borrowed money as her own.
Healthy vs. Danger Zone: Indian Benchmarks for D/E
Indian lenders find a debt-equity ratio of 2:1 as broadly reasonable, with somewhat higher leverage tolerated for traders and certain SME advances. Use these bands as a working guide:
Ratio | What it signals |
Below 1.0 | Conservative. Strong borrowing headroom. |
1.0 – 2.0 | Healthy for most MSMEs. Banks are comfortable here. |
2.0 – 3.0 | Stretched. Expect tighter terms, higher pricing, and more collateral. |
Above 3.0 | Danger zone. Fresh credit becomes difficult; existing limits may be reviewed. |
Two points to remember with this table. First, benchmarks are industry-specific; a capital-heavy manufacturing unit and an asset-light service firm should not be judged identically. Second, D/E is never read alone. Lenders also check other metrics like the Debt Service Coverage Ratio (DSCR). A business can show an acceptable D/E and still fail to get approved for another funding.
How to Fix a Bad D/E Ratio for your Business?
Look at the formula again. Debt on top, equity at the bottom. Therefore, only two options (lever) exist:
Lever 1: Increase equity
Infuse fresh capital or retain more profit. For most MSME owners under pressure, fresh capital isn’t available, and retaining profit takes years when interest outgo is already eating the margin.
Lever 2: Reduce total outstanding debt
Reducing debt is the lever most owners actually control, and it is the one that moves the ratio fastest.
Remember, paying EMIs on schedule while borrowing from another afloat does not reduce total outstanding debt; it simply reshuffles it. The ratio doesn’t move.
How a CIDA Moves the D/E Number?
A structured Company Informal Debt Arrangement Plan (CIDA) attacks the numerator directly. Rather than servicing every account at whatever terms you originally signed, under CIDA, your business liability is renegotiated for tenures, reduced interest burden, and most importantly breathing space for you to start focusing on profitability.
The effect on the ratio is mechanical. If Meera’s ₹55 lakh comes down to ₹40 lakh over 24 months while her equity holds or increases at ₹25 lakh, her D/E moves from 2.2 to 1.6. Now she might get approval faster from lenders.
Critical legal services like protection against insolvency or bankruptcy further shields your long-term plans.
Start With the Debt-to-Equity Number
Before any restructuring conversation is useful, you need one honest figure: your debt-to-equity ratio.
That single calculation tells you whether you’re managing a business or a debt cycle. Meanwhile, paralegal interventions for creditor harassment relief starts offering you peace of mind. It is also exactly where a free consultation with SingleDebt Business begins.
Calculate it this week. After all, the number won’t improve on its own.
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