What is a good debt to working capital ratio?
Generally, a working capital ratio of less than one is taken as indicative of potential future liquidity problems, while a ratio of 1.5 to two is interpreted as indicating a company is on the solid financial ground in terms of liquidity.
The optimal D/E ratio varies by industry, but it should not be above a level of 2.0. A D/E ratio of 2 indicates the company derives two-thirds of its capital financing from debt and one-third from shareholder equity.
Businesses will tend to aim for a working capital ratio between 1.2 and 2. Slipping below 1.2 could mean the business will struggle to pay its bills, depending on its operating cycle and how quickly it can collect receivables. Below 1, a business is operating with a net negative working capital position.
Most analysts consider the ideal working capital ratio to be between 1.5 and 2.
What is a good working capital ratio? A good working capital ratio (remember, there is no difference between current ratio and working capital ratio) is considered to be between 1.5 and 2, and suggests a company is on solid ground.
A ratio below 1.0 is unfavorable, as it indicates the company's current assets are not sufficient to cover near-term obligations.
This ratio refers to how much of a company's assets are financed with debt. If a company's debt ratio, which is debts divided by assets, is more than one that means the company has more debt than assets. On the other hand, a ratio below one means a company's assets outweigh its debts.
Generally, a lower ratio is better, as it implies that the company is in less debt and is less risky for lenders and investors. A debt-to-equity ratio of 0.5 or below is considered good.
Determining a Good Working Capital Ratio
Generally, a working capital ratio of less than one is taken as indicative of potential future liquidity problems, while a ratio of 1.5 to two is interpreted as indicating a company is on the solid financial ground in terms of liquidity.
A working capital turnover ratio of less than one can indicate potential future liquidity problems. If an organization had a ratio of 0.5, it might evaluate its operations to determine more cost-effective operational solutions.
Do you want a high or low working capital ratio?
The more positive the number, the more ability there will be to service those liabilities. Ideally you want your working capital ratio to be over 1.5, and closer to 2.
1.0 to 2.0: Short-term liquidity is optimal. The company is on firm financial footing and has positive working capital. 2.0 and above: While high working capital is definitely preferable to low in most cases, a current ratio that's too high can actually be a sign of underutilized capital.
Working Capital Ratio = Current Assets ÷ Current Liabilities
For example, if your business has $500,000 in assets and $250,000 in liabilities, your working capital ratio is calculated by dividing the two. In this case, the ratio is 2.0.
Low working capital can indicate a problem: the business is barely getting by and has just enough capital to cover its short-term expenses. Low working capital can also indicate good value: a business has invested excess cash to generate a higher rate of return.
Key Takeaways
Working capital management involves tracking various ratios, including the working capital ratio, the collection ratio, and the inventory ratio.
Debt that helps put you in a better position may be considered "good debt." Borrowing to invest in a small business, education, or real estate is generally considered “good debt,” because you are investing the money you borrow in an asset that will improve your overall financial picture.
In general, if your debt-to-equity ratio is too high, it's a signal that your company may be in financial distress and unable to pay your debtors. But if it's too low, it's a sign that your company is over-relying on equity to finance your business, which can be costly and inefficient.
Interpreting the Debt Ratio
If the ratio is over 1, a company has more debt than assets. If the ratio is below 1, the company has more assets than debt. Broadly speaking, ratios of 60% (0.6) or more are considered high, while ratios of 40% (0.4) or less are considered low.
A very low ratio also means you can take advantage of your equity to take out loans if you want. A high ratio is anything over 40% or 0.4. A low ratio is less than 36% (0.36) with a mortgage or 10% (0.1) without a mortgage. People often have questions about specific debt to equity ratios.
How much debt should a small business have? As a general rule, you shouldn't have more than 30% of your business capital in credit debt; exceeding this percentage tells lenders you may be not profitable or responsible with your money.
How much debt is acceptable?
Debt-to-income ratio is your monthly debt obligations compared to your gross monthly income (before taxes), expressed as a percentage. A good debt-to-income ratio is less than or equal to 36%.
DTI is one factor that can help lenders decide whether you can repay the money you have borrowed or take on more debt. A good debt-to-income ratio is below 43%, and many lenders prefer 36% or below. Learn more about how debt-to-income ratio is calculated and how you can improve yours.
Read our editorial guidelines here . Your debt-to-income (DTI) ratio is how much money you earn versus what you spend. It's calculated by dividing your monthly debts by your gross monthly income. Generally, it's a good idea to keep your DTI ratio below 43%, though 35% or less is considered “good.”
If the ratio is below 1, the company has more assets than debt. Broadly speaking, ratios of 60% (0.6) or more are considered high, while ratios of 40% (0.4) or less are considered low. However, what constitutes a “good debt ratio” can vary depending on industry norms, business objectives, and economic conditions.
Generally, a DTI of 20% or less is considered low and at or below 43% is the rule of thumb for getting a qualified mortgage, according to the CFPB. Lenders for personal loans tend to be more lenient with DTI than mortgage lenders. In all cases, however, the lower your DTI, the better.
