What Is the Debt Ratio?

This financial comparison, however, is a global measurement that is designed to measure the company as a whole. If the majority of your assets have been funded by creditors in the form of loans, the company is considered highly leveraged. In turn, if the majority of assets are owned by shareholders, the company is considered less leveraged and more financially stable. All accounting ratios are designed to provide insight into your company’s financial performance.

Some sources consider the debt ratio to be total liabilities divided by total assets. This reflects a certain ambiguity between the terms debt and liabilities that depends on the circumstance. The debt-to-equity ratio, for example, is closely related to and more common than the debt ratio, instead, using total liabilities as the numerator.

What is the debt to total assets ratio?

The debt-to-total-asset ratio changes over time based on changes in either liabilities or assets. If there is a significant increase in total liabilities, then this will affect the debt-to-total asset ratio positively. Similarly, a decrease in total liabilities leads to a lower debt-to-total asset ratio. On the other hand, a change in total assets will lead to a change in the debt-to-total asset ratio in the opposite direction, either positive or negative. The debt-to-total-assets ratio is important for companies and creditors because it shows how financially stable a company is. A debt-to-equity ratio of 1.5 would indicate that the company in question has $1.50 of debt for every $1 of equity.

As noted above, a company’s debt ratio is a measure of the extent of its financial leverage. Capital-intensive businesses, such as utilities and pipelines tend to have much higher debt ratios than others like the technology sector. 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. The business owner or financial manager can gain a lot of insight into the firm’s financial leverage through trend analysis. It simply means that the company has decided to prioritize raising money by issuing stock to investors instead of taking out loans at a bank.

One of its major drawbacks is that it doesn’t distinguish between types of assets—whether they are liquid or illiquid, tangible or intangible. To assess the types of assets and their liquidity, see this liquidity ratios article. While it’s important to know how to calculate the debt-to-asset ratio for your business, it has no purpose if you don’t understand what the results of that calculation actually mean. The debt-to-asset ratio is used by investors and financial institutions to determine the financial risk of a particular business. You will need to run a balance sheet in your accounting software application in order to obtain your total assets and total liabilities. Certain sectors are more prone to large levels of indebtedness than others, however.

The growing reliance on debt could eventually lead to difficulties in servicing the company’s current loan obligations. Very high D/E ratios may eventually result in a loan default or bankruptcy. If a company has a negative D/E ratio, this means that it has negative shareholder equity. In most cases, this would be considered a sign of high risk and an incentive to seek bankruptcy protection. Debt-to-equity ratio is most useful when used to compare direct competitors.

• If some of the firms use one inventory accounting method or one depreciation method and other firms use other methods, then any comparison will not be valid.
• This will determine whether additional loans will be extended to the firm.
• In most cases, this is considered a very risky sign, indicating that the company may be at risk of bankruptcy.
• For example, start-up tech companies are often more reliant on private investors and will have lower total-debt-to-total-asset calculations.
• Total Debt to Asset Ratio, also known as Debt Ratio, is a financial measure of a company’s leverage, calculated by dividing its total debt by total assets.

As is often the case, comparisons of the debt ratio among different companies are meaningful only if the companies are similar, e.g. of the same industry, with a similar revenue model, etc. All else being equal, the lower the debt ratio, the more likely the company will continue operating and remain solvent. Keep reading to learn more about what these ratios mean and how they’re used by corporations. An increasing trend indicates that a business is unwilling or unable to pay down its debt, which could indicate a default at some point in the future and possible bankruptcy.

What Is a Good Debt Ratio?

A company with a high debt ratio relative to its peers would probably find it expensive to borrow and could find itself in a crunch if circumstances change. Conversely, a debt level of 40% may be easily manageable for a company in a sector such as utilities, where cash flows are stable and higher debt ratios are the norm. This tells you that 40.7% of your firm is financed by debt financing and 59.3% of your firm’s assets are financed by your investors or by equity financing. The ratio can be expressed as a percentage, which in this example would be 60%. Generally, a lower debt ratio indicates a stronger financial position, as the business is better able to meet debt obligations and greater liquidity is maintained.

Example of the Debt to Assets Ratio

Both ratios, however, encompass all of a business’s assets, including tangible assets such as equipment and inventory and intangible assets such as accounts receivables. Because the total debt to assets ratio dcf terminal value formula includes more of a company’s liabilities, this number is almost always higher than a company’s long-term debt to assets ratio. Total debt to asset ratio is used to assess the solvency and risk of a business.

Analysis

The total-debt-to-total-asset ratio is calculated by dividing a company’s total debts by its total assets. Total-debt-to-total-assets is a measure of the company’s assets that are financed by debt rather than equity. When calculated over a number of years, this leverage ratio shows how a company has grown and acquired its assets as a function of time.

A ratio that is greater than 1 or a debt-to-total-assets ratio of more than 100% means that the company’s liabilities are greater than its assets. A ratio that is less than 1 or a debt-to-total-assets ratio of less than 100% means that the company has greater assets than liabilities. A ratio that equates to 1 or a 100% debt-to-total-assets ratio means that the company’s liabilities are equally the same as with its assets. Furthermore, prospective investors may be discouraged from investing in a company with a high debt-to-total-assets ratio.

In the banking and financial services sector, a relatively high D/E ratio is commonplace. Banks carry higher amounts of debt because they own substantial fixed assets in the form of branch networks. Higher D/E ratios can also tend to predominate in other capital-intensive sectors heavily reliant on debt financing, such as airlines and industrials. On the other hand, the typically steady preferred dividend, par value, and liquidation rights make preferred shares look more like debt.

Debt to Asset Ratio Calculator – Excel Model Template

A higher total assets to debt ratio represents more security to the lenders of long-term loans. However, lower total assets to debt ratio represent less security to the lenders of long-term loans, which indicates more dependence of the firm on long-term borrowed funds. Total Assets to Debt Ratio is the ratio, through which the total assets of a company are expressed in relation to its long-term debts. It is a variation of the debt-equity ratio and gives the same indication as the debt-equity ratio. Analysts, investors, and creditors use this measurement to evaluate the overall risk of a company.

Investors use the ratio to evaluate whether the company has enough funds to meet its current debt obligations and to assess whether the company can pay a return on its investment. Creditors use the ratio to see how much debt the company already has and whether the company can repay its existing debt. This will determine whether additional loans will be extended to the firm. If the calculation yields a result greater than 1, this means the company is technically insolvent as it has more liabilities than all of its assets combined. A calculation of 0.5 (or 50%) means that 50% of the company’s assets are financed using debt (with the other half being financed through equity).

As is the story with most financial ratios, you can take the calculation and compare it over time, against competitors, or against benchmarks to truly extract the most valuable information from the ratio. As with all other ratios, the trend of the total-debt-to-total-assets ratio should be evaluated over time. This will help assess whether the company’s financial risk profile is improving or deteriorating. For example, an increasing trend indicates that a business is unwilling or unable to pay down its debt, which could indicate a default in the future.

The same principal amount is more expensive to pay off at a 10% interest rate than it is at 5%. A higher debt ratio (0.6 or higher) makes it more difficult to borrow money. Lenders often have debt ratio limits and do not extend further credit to firms that are overleveraged.