This is the proportion of debt to equity that a company is using to finance its assets. Depending on how you plan to operate the business (cash based, with debt, investors, or some other combination) will determine how important this number is to the company.
The formula: Liabilities / Equity = Debt-to-Equity Ratio
What does this look like?
- Obviously, if you're operating on a cash basis you have no debt, but keep in mind that utilities are still considered a liability. Therefor this ratio remains important, but not as critical.
- On the other hand, if you're using debt to finance operations, then this number becomes critical.
- If investors are involved, then they're going to require this number.
- And lastly, even if you're using a combination or some other variation on what is listed here, then knowing this number becomes very important.
Here's why: Knowing this number gives you a better idea of how well the company can pay debts and how well it can pay the bills. If a company is sitting with very little assets and a pile of debt, then the company would be viewed as less financially healthy. On the other hand, if you're flush with cash, then paying the bills or taking a little risk isn't, well, as risky.
What to remember: However a company chooses to operate, whether with debt, without, or some combination thereof, it must know the numbers. It should never be assumed, since the company can make the payments, that everything is ok.