QandAs: Loans

What is Debt Equity?

Answer:
If you operate a business and want to apply for a loan,

the financial institution will take several factors into consideration. Banks lend money to individuals and businesses. However, the business of lending money is extremely risky, and lenders want to ensure that each applicant is capable of repaying the money.

Before approving a small business or corporation for new financing, lenders typically evaluate their debt equity ratio. Debt equity is simply a company’s total debts divided by their total equity. To succeed, every business needs working capital.

There are two ways to access this capital. A few businesses choose to finance their corporations with debt, which is money that must be repaid. On the other hand, some businesses choose to finance their corporations with their own money (equity).

When applying for a business loan, banks and credit unions typically like to see a low debt equity. High debt equity indicates too much debt. In turn, it can be difficult to obtain financing because a private investor or bank will consider the business too risky.

If high debts are accompanied with little equity, investors and banks may question the business owner’s competence, and whether the business is being managed efficiently.