What the Long-Term Debt to Equity Ratio Tells You About Business Risk
Debt isn’t always the problem. What matters is what your debt trends are telling you about the health of your business.
In this episode of Financially Fit Business, I talk about the difference between debt to equity and long-term debt to equity, why one tends to move around more than the other, and why long-term debt often gives you a better read on business risk over time.
Why This Ratio Matters
A lot of business owners see debt and immediately think something’s wrong. That’s not always the case.
Debt to equity includes both current liabilities and long-term liabilities. That means the number can shift for perfectly normal reasons, especially if you’re buying materials for a large job, carrying inventory, or making short-term operating decisions. Because of that, debt to equity can move up and down without pointing to a major problem.
Long-term debt to equity is often more useful because it focuses on debt that stays with the business over time. That makes it a better ratio for understanding whether your company is becoming more financially stable or taking on too much long-term risk.
What I Look For
In many small businesses, I want to see long-term debt to equity going down over time or sitting at zero. Some owners prefer to avoid long-term debt altogether. Others use it strategically. Either approach can work. The key is understanding what the number means for your business and paying attention when the trend stops making sense.
If long-term debt to equity suddenly jumps, I want to know why. Maybe the company bought equipment. Maybe it financed an acquisition. Maybe there was another major event. A sudden change usually means something important happened.
If the ratio starts creeping up over time, that’s a different kind of warning sign. It may mean profitability is slipping, equity is shrinking, and the business is becoming more financially vulnerable.
Why Debt to Equity Can Be Misleading
This is one reason I don’t put as much weight on the standard debt to equity ratio by itself.
It can fluctuate for everyday reasons. If you’re in an industry where you buy heavily for jobs or projects, debt to equity may rise simply because current liabilities rise. That doesn’t automatically mean something is wrong. It may just reflect how the business operates.
That’s why context matters. A ratio is only useful when you understand what’s driving it.
A Better Question to Ask
Instead of asking, “Is debt bad?” ask, “What is this ratio telling me about risk, profitability, and financial stability?”
That’s the better conversation.
For example, if you’re deciding whether to finance trucks, equipment, or another major purchase, run the numbers both ways. Compare using savings versus taking on debt. Then make the decision based on your goals, your cash position, and your comfort level with long-term obligations.
What to Watch For
- A sudden spike in debt to equity or long-term debt to equity
- Long-term debt to equity rising when no new debt should have been added
- Debt ratios increasing while profitability is falling
- Equity shrinking over time, which can push these ratios in the wrong direction
These kinds of changes don’t always mean trouble, but they do mean it’s time to ask questions.
Turn Your Financial Statements Into Better Business Decisions
Small changes in your financial statements can turn into much bigger problems if you ignore them long enough.
That’s why I encourage business owners to pay attention to trends early, especially when it comes to balance sheet ratios like long-term debt to equity. The sooner you understand what the numbers are telling you, the sooner you can make better decisions.
Listen to the episode above, then choose one thing you discovered and put it to work in your business.
If you want more clarity around your business numbers, explore how Financially Fit Business can help you turn financial statements into better decisions.
Common Questions About Debt to Equity Ratios
What is the long-term debt to equity ratio?
The long-term debt to equity ratio compares a company’s long-term debt to its equity. It helps show how much of the business is financed by long-term borrowing versus owner value.
Why does long-term debt to equity matter?
It matters because it can reveal whether a business is becoming more financially stable or taking on too much long-term debt. Over time, rising ratios may point to higher risk.
What is the difference between debt to equity and long-term debt to equity?
Debt to equity includes both current and long-term liabilities. Long-term debt to equity looks only at debt that extends beyond one year, which often makes it more useful for spotting longer-term financial risk.
Is a high debt to equity ratio always bad?
No. Sometimes businesses take on debt for growth, equipment, or acquisitions. What matters most is why the ratio changed and whether the business can support that debt profitably.
What can cause debt to equity to increase?
Debt to equity can increase because of new borrowing, large purchases, acquisitions, declining profitability, or shrinking equity.