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# Debt Ratio Definition, Components, Formula, Types, Pros & Cons

July 26, 2024
Bill Kimball

The debt to asset ratio is a leverage ratio that measures the amount of total assets that are financed by creditors instead of investors. In other words, it shows what percentage of assets is funded by borrowing compared with the percentage of resources that are funded by the investors. The term ‘debt ratio,’ ‘debt to assets ratio,’ and ‘total debt to total assets ratio’ are synonymously used. The debt-to-asset ratio represents the percentage of total debt financing the firm uses as compared to the percentage of the firm’s total assets. It helps you see how much of your company assets were financed using debt financing.

## How Do You Calculate the Debt Ratio?

It also gives financial managers critical insight into a firm’s financial health or distress. The term debt ratio refers to a financial ratio that measures the extent of a company’s leverage. The debt ratio is defined as the ratio of total debt to total assets, expressed as a decimal or percentage. It can be interpreted as the proportion of a company’s assets that are financed by debt. As with all other ratios, the trend of the total debt-to-total assets ratio should be evaluated over time.

## Understanding the debt to assets Ratio

This will help the analyst assess if the company’s financing risk profile is improving or deteriorating. For example, an increasing trend reflects that the business is unable to pay off its debt, leading to default. A proportion greater than 1 reflects that a significant portion of assets is funded by debt.

1. This company is extremely leveraged and highly risky to invest in or lend to.
2. It is calculated by dividing total liabilities by total assets, with higher debt ratios indicating higher degrees of debt financing.
3. It is one of many leverage ratios that may be used to understand a company’s capital structure.

Analysts will want to compare figures period over period (to assess the ratio over time), or against industry peers and/or a benchmark (to measure its relative performance). It represents the proportion (or the percentage of) assets that are financed by interest bearing liabilities, as opposed to being funded by suppliers or shareholders. As a result it’s slightly more popular with lenders, who are less likely to extend additional credit to a borrower with a very high debt to asset ratio. Last, businesses in the same industry can be contrasted using their debt ratios. It offers a comparison point to determine whether a company’s debt levels are higher or lower than those of its competitors. The debt ratio aids in determining a company’s capacity to service its long-term debt commitments.

## Debt Ratio FAQs

For a more complete picture, investors also look at metrics such as return on investment (ROI) and earnings per share (EPS) to determine the worthiness of an investment. To find a business’s debt ratio, divide the total debts of the business by the total assets of the business. Two companies with similar debt ratios might have significantly different interest obligations, impacting their overall financial performance and risk.

## What is the approximate value of your cash savings and other investments?

Creditors can use restrictive covenants to force excess cash flow to repayment and restrict alternative uses of cash. Similarly, a business may face a significant financial risk if its debt is subject to a sudden hike in interest rates. A ratio greater than 1 suggests that the company may be at risk of being unable to pay back its debt. A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation. Finance Strategists has an advertising relationship with some of the companies included on this website. We may earn a commission when you click on a link or make a purchase through the links on our site.

The debt to asset ratio is a leverage ratio that indicates the portion of a company’s assets financed with debt. In other words, it defines the total amount of debt relative to assets owned by the company. This leverage ratio is also used to determine the company’s financial risk. This ratio, calculated by dividing total liabilities by total assets, serves as a valuable tool for assessing a company’s financial stability, gauging risk exposure, and evaluating capital structure. To find relevant meaning in the ratio result, compare it with other years of ratio data for your firm using trend analysis or time-series analysis. Trend analysis is looking at the data from the firm’s balance sheet for several time periods and determining if the debt-to-asset ratio is increasing, decreasing, or staying the same.

As mentioned above, this formula has different variations that only include certain assets and liabilities. One example is the current ratio, which is a fraction of current assets over current liabilities. As mentioned before, for creditors, this ratio indicates if the company can service debt.

For the example above, company A is a well-established, stable company. On the other hand, investors use it to ensure that the company remains solvent and can meet current and future obligations. A ratio greater than one can prove to be a significant problem for businesses in cyclical industries where cashflows frequently fluctuate. This measure is closely watched by lenders and creditors since they want to know whether the company owes more money than it possesses.

Newer businesses or startups might rely heavily on debt financing to kick-start operations, leading to higher debt ratios. This can include long-term obligations, such as mortgages or other loans, and short-term debt like revolving credit lines and accounts payable. Analysts, investors, and creditors use this measurement to evaluate the overall risk of a company. Companies with a higher figure are considered more risky to invest in and loan to because they are more leveraged.

To illustrate, suppose the company had assets of \$2 million and liabilities of \$1.2 million. Since equity is equal to assets minus liabilities, the company’s equity would be \$800,000. Its debt-to-equity ratio would therefore be \$1.2 million divided by \$800,000, or 1.5. For example, in the example above, Hertz reported \$2.9 billion in intangible assets, \$1.3 billion in PPE, and \$1.04 billion in goodwill as part of its total \$20.9 billion of assets. Therefore, the company had more debt (\$18.2 billion) on its books than all of its \$15.7 billion current assets (assets that can be quickly converted to cash). Companies with strong operating incomes might comfortably manage higher debt loads, while those with weaker incomes might struggle even with lower debt ratios.

Because the total debt to assets ratio includes more of a company’s liabilities, this number is almost always higher than a company’s long-term debt to assets ratio. A company’s total debt-to-total assets ratio is specific to that company’s size, industry, sector, and capitalization strategy. For example, start-up tech companies are often more reliant on private investors and will have lower total debt-to-total-asset calculations. However, more secure, stable companies may find it easier to secure loans from banks and have higher ratios. In general, a ratio around 0.3 to 0.6 is where many investors will feel comfortable, though a company’s specific situation may yield different results. The debt to assets ratio formula is calculated by dividing total liabilities by total assets.

A lower percentage will reflect that the company is stable and that the investors can expect a higher return over assets. First, it illustrates the percentage of debt used to carry a company’s assets and how these assets can be used to service loans. For information pertaining to the registration status of 11 Financial, please contact the state securities regulators for those states in which 11 Financial maintains a registration filing. In this case, the company is not as financially stable and will have difficulty repaying creditors if it cannot generate enough income from its assets. The company in this situation is highly leveraged which means that it is more susceptible to bankruptcy if it cannot repay its lenders. Perhaps 53.6% isn’t so bad after all when you consider that the industry average was about 75%.

There is a sense that all debt ratio analysis must be done on a company-by-company basis. Balancing the dual risks of debt—credit risk and opportunity cost—is something that all companies must do. Investors and lenders calculate the debt ratio of a company from its financial statements. Whether or not a debt ratio is good depends on the contextual factors. Keep reading to learn more about what these ratios mean and how they’re used by corporations.

This is because lenders will charge higher interest rates on a company’s loan to compensate for the financial risk that they are taking. The debt-to-total-assets ratio is important for companies and creditors because it shows how financially stable a company is. A lower debt ratio often signifies robust equity, indicating resilience to economic challenges. Conversely, a higher ratio may suggest increased financial risk and potential difficulty in meeting obligations. Companies with high debt ratios might be viewed as having higher financial risk, potentially impacting their credit ratings or borrowing costs. By examining a company’s debt ratio, analysts and investors can gauge its financial risk relative to peers or industry averages.

The company will have to pay interest payments and principal, eating into the company’s profits. For ease of understanding, the companies are listed in ascending order of percentage. Company A has the highest financial flexibility, and company C with the highest financial leverage. On the other hand, this percentage illustrates income and profitability for investors.