When analyzing your risk of default on debts such as credits and loans, the debt to asset ratio can help show you the financial health of your business. Additionally, you may use the debt to asset ratio to compare earlier ratios as well as the business’ financial growth over time. When calculating the debt to asset ratio and interpreting the results, it can be highly important to know all the financial information you will need to use to determine the ratio.
In this article, you will learn how to calculate the debt to asset ratio and what those results mean for your business.
What is the debt to asset ratio?
The debt to asset ratio, or total debt to total assets ratio, is an indication of a company’s financial leverage. A company’s debt to asset ratio measures its assets financed by liabilities (debts) rather than its equity. This ratio can be used to measure a company’s growth through its acquired assets over time. Investors can use the debt to asset ratio to evaluate whether a business has enough funding to meet its debt obligations, as well as to assess whether an organization can pay returns on investments.
Additionally, the debt to asset ratio can be used as an indicator to measure a company’s financial leverage. It shows the percentage of a business’ total assets financed by creditors. The formula for calculating the debt to asset ratio looks like this:
Debt to asset ratio = (Total liabilities) / (Total assets)
The total amount of debts, or current liabilities, is divided by the total amount the company has in assets, whether short-term investments or long-term and capital assets. To calculate the total liabilities, both short-term and long-term debt is added together to get the total amount in liabilities a company owes.
How to calculate debt to asset ratio
To calculate the debt to asset ratio, you must first analyze the financial balance sheet of your business. It can also be helpful to calculate the debt to asset ratio over the time the business has been operating, giving a full picture of the financial growth or decay of the company. The following steps show you how to apply the debt to asset formula to calculate the ratio:
- Calculate the total liabilities
- Calculate the total assets
- Place both amounts in appropriate spots in the formula
Calculate debt to asset ratio using the formula
1. Calculate total liabilities
Your first step in calculating your debt to asset ratio is to calculate all the current liabilities of the business. You might have short-term loans, longer-term debts or other liabilities incurred over time. Once you get this amount, it can fit into the formula. For instance, a company might calculate all small business loans it has received and is paying back, as well as any funding from creditors the business has received over the course of its operation.
2. Calculate total assets
After calculating all current liabilities, you can then calculate the total amount the business has in assets. These assets can include quick assets (such as cash and cash equivalents), long-term investments and any other investments that have generated revenue for your business. Once you have this amount, place it in the appropriate area of the debt to asset ratio formula.
3. Place both amounts in appropriate spots in the formula
Once both amounts have been calculated, place each element into the debt to asset ratio formula. The total liabilities will be the dividend, while the total amount in assets acts as the divisor.
4. Calculate debt to asset ratio using the formula
Now that your amounts are placed in their appropriate spots in the formula, you can go ahead and calculate your debt to asset ratio. Divide the total liabilities by the total assets, and your result should appear as a decimal. This can also be converted to a percentage, which tells the percent of liabilities that are financed by creditors, investors or other such entities.
Interpreting the debt to asset ratio
Once you have calculated the debt to asset ratio, you can then analyze the results. Typically, a debt to asset ratio of greater than one, such as 1.2, can indicate that a company’s liabilities are higher than its assets. Additionally, a debt to asset ratio that is greater than one can also show that a large portion of the business’ debt is funded by its assets. Higher ratios usually indicate that a business may be at risk of defaulting on loans, especially if the interest rate increases.
A debt to asset ratio that is less than one, for instance, 0.64, can indicate that a considerable portion of your business’ assets is funded by equity, and that the risk for default or even bankruptcy is low. Furthermore, the decimal 0.64 can be converted to a percentage, indicating that 64% of your business liabilities are covered by your assets.
Debt to asset ratio example
It can sometimes be helpful to see an example that illustrates how this formula works, as well as the interpretation of the debt to asset ratio that results from your calculations. In the following example, we calculate the debt to asset ratio and then use the resulting number to analyze the risk of a company defaulting on a loan or the risk a company might have regarding filing for bankruptcy.
For example, let’s say the CEO of a mid-sized corporation wants to calculate the debt to asset ratio of the company. A financial advisor might assist in this process, and they would first analyze the company’s balance sheet to determine the total amount in liabilities as well as the total amount of assets.
- Total liabilities of the company = $38,000
- Total assets of the company = $100,000
Total stockholder’s equity = $62,000
The financial advisor then uses the debt to asset ratio formula to calculate the percentage:
(Total liabilities) / (total assets) = ($38,000) / ($100,000) = 0.38:1 or 38%
This ratio indicates that the company’s assets are financed by creditors or a loan, while 62% of the company’s asset costs are provided by the owners of the business. This ratio further indicates that this company has a low risk of defaulting on loans, which can be beneficial if the organization seeks further crediting for remodeling, expanding, growing product inventory or other expenses the company may need to take care of in the future.
In addition to the current calculation of the debt to asset ratio, the company may choose to compare the result to prior debt to asset ratios at earlier dates and over time, its targeted ratio and any competitor’s debt to asset ratio to help show what steps the business might need to take to lower its risk even more.
Debt-to-Asset Ratio Explained
A company’s debt-to-asset ratio is one of the groups of debt or leverage ratios that is included in financial ratio analysis. The debt-to-asset ratio shows the percentage of total assets that were paid for with borrowed money, represented by debt on the business firm’s balance sheet. It is an indicator of financial leverage or a measure of solvency. It also gives financial managers critical insight into a firm’s financial health or distress.
If, for instance, your company has a debt-to-asset ratio of 0.55, it means some form of debt has supplied 55% of every dollar of your company’s assets. If the debt has financed 55% of your firm’s operations, then equity has financed the remaining 45%.
A high debt-to-assets ratio could mean that your company will have trouble borrowing more money, or that it may borrow money only at a higher interest rate than if the ratio were lower. Highly leveraged companies may be putting themselves at risk of insolvency or bankruptcy depending upon the type of company and industry. Some industries can use more debt financing than others.
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 to Calculate the Debt-to-Asset Ratio
In order to calculate the business firm’s debt-to-asset ratio, you need to have access to the business firm’s balance sheet. Here is a hypothetical balance sheet for XYZ company:
|XYZ, Inc. December 31 Balance Sheet (Millions of Dollars)|
|Assets||2020||Liabilities and Equity||2020|
|Cash||$ 10||Accounts Payable||$ 160|
|Marketable Securities||0||Notes Payable||100|
|Accounts Receivable||175||Total Current Liabilities||260|
|Total Current Assets||1000||Total Liabilities||814|
|Net Plant and Equipment||1000||Shareholder Equity||1186|
|Total Assets||2000||Total Liabilities and Equity||2000|
Take the following three steps to calculate the debt to asset ratio. All information comes from your company’s balance sheet.
- To calculate the debt-to-asset ratio, look at the firm’s balance sheet, specifically, the liability (right-hand) side of the balance sheet. Add together the current liabilities and long-term debt.
- Look at the asset side (left-hand) of the balance sheet. Add together the current assets and the net fixed assets.
- Divide the result from step one (total liabilities or debt—TL) by the result from step two (total assets—TA). You will get a percentage. In this example for Company XYZ Inc., you have total liabilities (debt) of $814 million and total assets of $2,000.
So with Company XYZ, we would look at $814 million in total liabilities divided by $2,000 in total assets:
- Debt-to-Assets = 814 / 2000 = 40.7%
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.
Comparative Ratio Analysis
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.
The second comparative data analysis you should perform is industry analysis. In order to perform industry analysis, you look at the debt-to-asset ratio for other firms in your industry. If your debt-to-asset ratio is not similar, you try to determine why.
Why the Debt-to-Asset Ratio Is Important for Business
Companies with high debt-to-asset ratios may be at risk, especially if interest rates are increasing. Creditors prefer low debt-to-asset ratios because the lower the ratio, the more equity financing there is which serves as a cushion against creditors’ losses if the firm goes bankrupt. Creditors get concerned if the company carries a large percentage of debt. They may even call some of the debt the company owes them.
More equity financing, or owner-supplied funds, than debt financing means lower firm risk and a margin of safety for the firm and its creditors
Investors in the firm don’t necessarily agree with these conclusions. If the firm raises money through debt financing, the investors who hold the stock of the firm maintain their control without increasing their investment. Investors’ returns are magnified when the firm earns more on the investments it makes with borrowed money than it pays in interest. However, the investor’s risks are also magnified.
Limitations of the Debt-to-Asset Ratio
There are limitations when using the debt-to-assets ratio. The business owner or financial manager has to make sure that they are comparing apples to apples. In other words, if they are doing industry averages, they have to be sure that the other firm’s in the industry to which they are comparing their debt-to-asset ratios are using the same terms in the numerator and denominator of the equation.
For example, in the numerator of the equation, all of the firms in the industry must use either total debt or long-term debt. You can’t have some firms using total debt and other firms using just long-term debt or your data will be corrupted and you will get no helpful data.
Another issue is the use of different accounting practices by different businesses in an industry. 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.
Business managers and financial managers have to use good judgment and look beyond the numbers in order to get an accurate debt-to-asset ratio analysis.
What is the Debt to Assets Ratio?
The Debt to Assets Ratio is a leverage ratio Leverage Ratios A leverage ratio indicates the level of debt incurred by a business entity against several other accounts in its balance sheet, income statement, or cash flow statement. Excel template that helps quantify the degree to which a company’s operations are funded by debt. In many cases, a high leverage ratio is also indicative of a higher degree of financial risk. This is because a company that is heavily leveraged faces a higher chance of defaulting on its loans. It is legally obligated to make periodic debt payments regardless of its sales numbers. During slow sales cycles or difficult economic times, a highly levered company may experience a loss of solvency Insolvency Insolvency refers to the situation in which a firm or individual is unable to meet financial obligations to creditors as debts become due. Insolvency is a state of financial distress, whereas bankruptcy is a legal proceeding. as cash reserves dwindle.
The debt to assets ratio can also be thought of as the amount of a company’s assets that have been financed by debt. It can provide insights on past decisions made by management regarding the sources of capital they selected to pursue certain projects. By extension, we can also consider the debt to assets ratio as being an indirect way of measuring management’s usage of its capital structure Capital Structure Capital structure refers to the amount of debt and/or equity employed by a firm to fund its operations and finance its assets. A firm’s capital structure to fund NPV-positive projects.
How can we calculate the Debt to Assets Ratio?
The ratio can be calculated using the following formula:
Can be expressed as a percentage
Total Debt = Short Term Debt + Long Term Debt
Total Assets = The sum of the value of all the company’s assets found on a company’s balance sheet Balance Sheet The balance sheet is one of the three fundamental financial statements. These statements are key to both financial modeling and accounting
Max’s Coffee wants to calculate its debt to assets ratio in order to keep tabs on the company’s leverage. Below is the company’s balance sheet for the past few years:
From CFI’s Balance Sheet Template Balance Sheet Template This balance sheet template provides you with a foundation to build your own company’s financial statement showing the total assets, liabilities and shareholders’ equity. The balance sheet is based on the fundamental equation: Assets = Liabilities + Equity Using this template, you can add and remove line items under ea
The red boxes highlight the important information that we need to calculate debt to assets, namely, short-term debt, long-term debt, and total assets. Using the formula provided above, we arrive at the following figures:
In the example above, we can see that Max’s Coffee consistently posted a debt to assets ratio of over 100%. This shows us that Max’s has more debt than it has assets that can be liquidated in the case of bankruptcy. This would typically be an indicator of poor financial health, as Max’s has a very high degree of leverage. Due to the likely very high periodic debt payments, Max’s is at a fairly high risk of defaulting on its debt. Nonetheless, if the business is able to generate strong and steady cash flows in each period, this position may be sustainable.
To better understand the financial health of the business, the ratio should be computed for a number of companies that operate in the same industry. If other firms operating in this industry see a debt to asset ratio of, say, over 200%, then we can conclude that Max’s is doing a relatively good job of managing its degree of financial leverage. In turn, creditors may be more likely to lend more money to Max’s if the company represents a fairly safe investment within the coffee industry.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ Become a Certified Financial Modeling & Valuation Analyst (FMVA)® certification program for those looking to take their careers to the next level. To learn more about related topics, check out the following CFI resources:
- Leverage Effect Measures Leverage Effect Measures Leverage effect measures aim to quantify how much business risk a given company is currently experiencing. Business risk refers to the revenue variance that a business can expect to see, and how sensitive net income is to changes in revenues. Leverage effect measures aim to show how the business’ fixed and variable costs can impact profitability
- Current Portion of Long-Term Debt Current Portion of Long-Term Debt The current portion of long-term debt is the portion of long-term debt due that is due within a year’s time. Long-term debt has a maturity of
- Defensive Interval Ratio Defensive Interval Ratio The defensive interval ratio (DIR) is a financial liquidity ratio that indicates how many days a company can operate without needing to tap into capital sources other than its current assets. It is also known as the basic defense interval ratio (BDIR) or the defensive interval period ratio (DIPR).
- How to Calculate Debt Service Coverage Ratio How to Calculate Debt Service Coverage Ratio This guide will describe how to calculate the Debt Service Coverage Ratio. First, we will go over a brief description of the Debt Service Coverage Ratio, why it is important, and then go over step-by-step solutions to several examples of Debt Service Coverage Ratio Calculations.
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Formula to Calculate Debt Ratio
Debt ratio is the ratio of total debt liabilities of a company to the total assets of the company; this ratio represents the ability of a company to hold the debt and be in a position to repay the debt if necessary on an urgent basis. A company which has a debt liability of $30 million out of $100 million total assets, has a debt ratio of 0.3
It is one of the most used solvency ratios by investors. And it’s pretty easy to calculate too.
Let’s have a look at the formula of debt ratio –
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Source: Debt Ratio Formula (wallstreetmojo.com)
All you need to do is to look at the balance sheet and find out whether a firm has enough total assets to pay off its total liabilities.
For an investor, the financial statements are everything. They look at all four financial statements and make their judgments. One of the most important financial statements is the balance sheet. By looking at the balance sheet, the investors are able to know what’s working for a company and what needs to be improved.
Two of the most important items on the balance sheet are assets and liabilities. By looking at the total assets and the total liabilities, the investors are able to understand whether the firm has enough assets to pay off the liabilities. And that’s exactly what we call debt ratio.
By using this ratio, we calculate the proportion of the total assets and the total liabilities. And by looking at them, we get to know the stance of a company at any stage.
Let’s take a practical example to illustrate this formula of debt ratio.
Boom Company has the following details –
- Current Assets – $30,000
- Non-current Assets – $300,000
- Current Liabilities – $40,000
- Non-current Liabilities – $70,000
Find out the debt ratio of Boom Company.
In the above example, we can see that we need to total the current and non-current assets and also current liabilities and non-current liabilities.
- The total assets are = (Current Assets + Non-current Assets) = ($30,000 + $300,000) = $330,000.
- The total liabilities are = (Current Liabilities + Non-current Liabilities) = ($40,000 + $70,000) = $110,000.
- Debt ratio formula is = Total Liabilities / Total Assets = $110,000 / $330,000 = 1/3 = 0.33.
- The ratio of Boom Company is 0.33.
To know whether this proportion between total liabilities and total assets is healthy or not, we need to see similar companies under the same industry. If the ratio of those companies is also in a similar range, it means Boom Company is doing quite well.
In normal situations, as lower as this ratio can be, better it is in terms of investment and solvency.
Use of Debt Ratio Formula
This formula of debt ratio is useful for two groups of people.
- The first group is the top management of the company, which is directly responsible for the expansion or contraction of a company. By using this ratio, the top management sees whether the company has enough resources to pay off its obligations.
- The second group is the investors who would like to see the position of a company before they ever put in their money into the company. That’s why the investors need to know whether the firm has enough assets to bear the expenses of debts and other obligations.
This ratio also measures the financial leverage of the company. And it also tells the investors how leveraged the firm is. If the firm has a higher level of liabilities compared to assets, then the firm has more financial leverage and vice versa.
Debt Ratio Calculator
You can use the following Debt Ratio Calculator
|Debt Ratio Formula|
Calculate Debt Ratio in Excel (with excel template)
Let us now do the same example above in Excel.
It is very simple. You need to provide the two inputs of Total Liabilities and Total Assets.
You can easily calculate the ratio by using the formula of the debt ratio in the template provided.
You can download this Debt ratio template here – Debt Ratio Excel Template.
Debt Ratio Video
This article has been a guide to Debt Ratio Formula, practical examples, and debt ratio calculator along with excel templates. You may also have a look at these articles below to learn more about Financial Analysis –
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Debt to Assets Ratio Calculator
The debt to asset ratio is a correspondence between the total debt and the total assets of a company. It shows what percentage of the resources is funded by debt rather than equity.
A high debt to asset ratio implies a high financial risk. But it implies a higher equity return in case of a strong economy.
This scale is used commonly by stakeholders and creditors. The former group uses it to determine two factors: whether the given company has sufficient funds to pay its debts, and whether it can pay the return on the group’s investment.
The latter group (the creditors) determines the possibilities of giving supplementary loans to the enterprise. If the debt to asset ratio is remarkably high, it reveals that repaying preexisting debts is already improbable and additional loans are a risky investment.
Debt to assets ratio formula
To compute the debt to asset ratio, you have to read two factors from your company’s balance sheet:
- Total debt – determined by adding short term debt (any debts due within a short time period) and long term debt.
- Total resources of the company.
Given below is the debt to asset ratio formula:
Debt to asset ratio = (short term debt + long term debt) / total resources (Assets) * 100%
This scale is typically represented as a percentage. However, you might come across a value like 0.56 or 1.22. To obtain a result in percentages, just multiply this type of value by 100%.
How to calculate the debt to asset ratio?
Consider that you’re a banker. Two enterprises approach you for a long term loan. You can read and analyze the information from their balance sheets that have been given below.
- Total debt: $300.50M
- Total assets: $850.20M
- Total debt: $240.60M
- Total assets: $200.68M
Employing the debt to asset ratio formula for both of the companies, we arrive at the following result:
Now as you can see above, the values for the debt to asset ratio are completely different. What do these results imply? The proportion for company A is somewhat low – it implies that most of the company’s assets are financed by equity.
Armed with this information, we can conclude that company A is in a decently good financial shape. Company B, however, is rather in a far riskier state, as their liabilities exceed their assets/resources. For a bank, it is logical to give loan to company A only.
The above example displays that the relation between the debt to asset ratio and the company’s financial condition is simple: the higher the percentage, the riskier its financial health.
If the company’s debt to asset ratio exceeds 100%, it means that a company has more liabilities (usually in the form of debt) than assets/resources and may even declare bankruptcy soon.
However, going all through this manually could be a tough nut to crack and we’re not even talking Human Error yet. So it is better to
However, there are definitely upsides to a higher debt to asset ratio. It shows a sharp degree of flexibility, which resultantly means higher returns in the case of success (provided that someone is willing to invest in your high-risk company).
Undeniably, however, debt to asset ratio is not the only gauge of a company’s debt/liabilities management. To get the bigger picture for B, you should also take note of the other metrics like their debt services coverage ratio.
However, going through all these calculations manually can be a tough nut to crack and we’re not even talking Human Error yet. Thus, Soft has developed this Debt to Assets Ratio Calculator.
It calculates the debt to assets ratio based on the total debt ratio formula and delivers results in real-time. On top of that, it is free to use tool no matter how many times you use it. The cherry on top is you don’t have to register to the site either.
Our tool is extremely useful for bankers, other financial institutions and corporate companies. Analysts and Investors use this calculator to determine the risk of investing in a company.
Debt ratio is a measurement that indicates how much leverage a company uses to finance its operation by using debt instead of its truly owned capital or equity. The ratio does this by calculating the proportion of the company’s debts as part of the company’s total assets. This is the combination of total debts and total equity.
As mentioned, total assets are the culmination of total equity plus liabilities, both long-term and short-term. If debts incorporate the larger part of a company’s assets, it means that the company has a higher risk to no longer be able to meet its financial obligations or insolvency. On the contrary, companies that has higher equity percentage among assets are comparably better at managing the risk in order to fulfil the assets requirements and avoid bankruptcy at the same time.
The debt ratio is one of many tools investors or creditors use to gauge how much leverage a company uses to improve its capital or assets in the hope of gaining more profits. The debt ratio can also be referred to as the debt to asset ratio. Both of these ratios have the same formula.
Debt Ratio Formula
To determine the debt ratio, we will need to know the total liabilities (debt) and total assets. These values can be easily found on the balance sheet. Total debts can also be obtained by subtracting equity—also known as shareholders’ equity—from total assets. Total liabilities needs to include both short-term debts and long-term debts.
A company with a high debt ratio is using more debts than equity. This means a majority of the company’s assets come from borrowed capital. These companies believed that in exchange for taking more risks, they could generate more income and be more profitable in the long run. Ideally, companies should not unwittingly incur too many debts or take on unnecessary ones. These can result in detrimental consequences.
In different circumstances, corporations that are using fewer debts are less risky as they’re adopting a more conservative approach to their business. Not only that, but investors are also relatively more attracted to these businesses since the risks are more manageable. Alternatively, potential lending institutions such as banks are also more inclined to prolong their credit. These companies have a higher chance of continuing to meet their payment duty on time.
The debt ratio can be expressed as either decimal or percentage. Simply multiply the result of the equation to 100% to make it a percentage. Companies with a debt ratio of less than 50% are often preferred by creditors and inventors. With that said, to get a more accurate result, it may be a good idea to compare the debt ration of the company in multiple periods to check for consistencies.
Debt Ratio Example
An investor named Sandra wishes to know if a utility company she interested in is a good candidate to put her money on. Sandra decided to use the debt ratio of the company from last year’s results as one of the bases of her decision. She can determine the company’s total assets to be $13,000,000 after looking at the company’s balance sheet she obtained. She also found out that the company the combined amount of short-term debts and long-term debts of $3,900,000. Can we calculate the company’s debt ratio based on this data?
Let’s break it down to identify the meaning and value of the different variables in this problem.
- Total liabilities: 4,900,000
- Total assets: 13,000,000
We can apply the values to our variables and calculate the debt ratio:
$$Debt\: Ratio =\dfrac<4<,>900<,>000><13<,>000<,>000> = 0.3769$$
In this case, the debt ratio would be 0.3769 or 37.69%.
From the result above, we can see that the utility company has taken the somewhat conservative approach of not using too much leverage to finance the assets. This can be concluded from the less than than 50% of the debt ratio. In this case, Sandra can be more rest assured investing in this company even if for some reasons the company may not do well.
Debt Ratio Analysis
The debt ratio can tell us how dependent a company is to debt. Some businesses use leverage as a strategy to have more potential earning, by using loaned money to boost resources while also incurring more risks. Whether a debt ratio of a company is too high or too low depends on the industry it operates. Companies with stable cash flows such as pipelines or utility companies tend to have a higher debt ratio on average. In contrast, technology companies that has more volatile cash flows tend to have a lower debt ratio.
Leverage measurement ratios such as debt ratio are often used by lenders and investors to indicates how safe financially a company is. These candidates of capital donors will more likely go for companies that rely on equity or shareholders’ equity—the capital they truly own. Lenders are more willing to put their money on the company while investors will have an easier time sleeping at night in the period of financial adversaries.
A low debt ratio is a signal indicating that the company is managing its risks wisely. It will most likely able to pay off its due debts on time. A low debt ratio will also reduce the likelihood of bankruptcy or the inability state of business to pay its debts resulting in a legal proceeding with its lenders. Besides, a lower debt ratio also serves as a prevention measure in case lenders decided to up their interests.
With that said, an extremely low debt ratio—compared to the competitors in the same industry—does not always hint that the company is effectively managing its business. A very low debt ratio indeed means fewer risks involved. However, the lack of funds the company has may hinder it to grow the way it potentially should. The company may struggle to run its business activity effectively and receive less return as a result. To gain maximum profits, investors should look for a company that aims for the same thing while also does not neglect risks.
Debt Ratio Conclusion
- The debt ratio indicates how much leverage a company uses to supply its assets using debts. Debt ratio is the same as debt to asset ratio and both have the same formula.
- The formula for debt ratio requires two variables: total liabilities and total assets.
- The results of the debt ratio can be expressed in percentage or decimal.
- The amount of a good debt ratio should depend on the industry.
- Lower debt ratios can offer financial protection.
- If a debt ratio is too low, companies wouldn’t use debt as a tool for growth.
Debt Ratio Calculator
You can use the debt ratio calculator below to quickly determine the leverage a company uses to supply its assets using debts by entering the required numbers.
Long Term Debt Ratio
A long-term debt ratio calculator is an online tool for calculating long-term debt to total asset ratio. We calculate long term debt ratio to get a knowledge of portion of asset financed by the way of debt. It is one of the several leverage ratios. Businesses usually calculate the long-term debt ratio each year. In normal circumstances, an entity always strives to have this ratio as low as possible. That means it wishes to have negative growth in this ratio each year. Generally, we analyze this ratio from the angles of financial leverage and bankruptcy risk.
Formula for calculating Long Term Debt Ratio
We can calculate the long-term debt ratio by dividing long-term debts by the total assets. A mathematical representation for the same is as follows:
Long Term Debt Ratio = Long Term Debt / Total Assets
About the Calculator / Features
The calculator provides a quick and correct calculation of long term debt ratio to the user by simply providing following details into it.
- Long term debt
- Total assets
How to Calculate using Calculator
The user have to insert following data into the calculator to get instant result of the calculation in a simple click.
Long Term Debt
It comprises all borrowings of the company that mature after a period of 1 year or more. Such debt are associated with an obligation to make of fixed payments at regular intervals. Long term debt helps a company to fund its capital and long-term investments. The details of these are available in the balance sheet on the liability side under the heading of non-current liabilities / secured and unsecured loans.
Assets are the resources of the company held to generate profits in the long term. These are broadly classified as current assets and non-current assets. Assets that are with the company for a period of 1 year only are the current assets. And non-current or fixed assets are held for a period of more than 1 year. The details of fixed assets will be available in the balance sheet on the Assets Side under the heading of Fixed Assets.
Example of Long Term Debt Ratio
Let us try to understand this concept with the help of an example.
A company X Ltd. has total assets worth $15,000 and long term debt of $8,500. The long term debt ratio of the company is:
Long Term Debt Ratio = 8,500 / 15,000 = 0.5667 or 56.67%
Interpretation of Long Term Debt Ratio
The ratio provides the insight about the stability and risk level of the company. Generally, a ratio less than 0.5 (that is, less than 50%) is a good indicator. In the example above, the ratio is 56.67% which is more than the ideal level. A ratio less than 50% implies that the portion of equity in financing asset is more than debt or vice versa.
We must also note that the level of debt funds and the ratio varies with the industry also. If it is a capital-intensive industry, the debt portion/ratio will be high.
One may prefer to finance the investments/assets through equity only. This will avoid the financing costs as well as the solvency issues. However, this limits the growth plans of the business. Hence, one has no option but to go for debts for financing part of its assets. Moreover, the cost of equity is more as compared to debt because of the tax-deductibility of interest on debts. So all the businesses opt for debt financing.
The major problem with long-term debt is the blockage of cash for interest and principal payments on a regular basis. Higher the long-term debts, the more the blockage of funds. A higher long-term ratio represents a high risk of insolvency. Hence, it is always advisable to adopt an optimal debt-equity mix to save on the cost of capital keeping into account the sustainability and repayment capacity.
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Sanjay Bulaki Borad
Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain “Financial Management Concepts in Layman’s Terms”.
Borrowing money is often essential to the success of any business. Being approved for a loan or line of credit requires convincing prospective lenders and/or investors of your company’s credibility and the likelihood of a positive return on their investment. Among other factors, financial professionals use a formula known as the debt ratio formula to inform their lending and investing decisions. In this article, we explain what the debt ratio formula is and how to calculate and interpret it.
What is the debt ratio formula?
The debt ratio formula, sometimes known as the debt to asset ratio, is a financial mathematical formula that calculates the ratio between a company’s debts and assets. For this formula, debts include all of a company’s short and long-term liabilities, also known as financial obligations. Short-term liabilities include things like rent, payroll or accounts payable. Long-term liabilities include things like pension obligations or financial loans. Assets refer to anything that a company owns that has value. This includes things like cash, property, product inventory or investments.
The debt ratio formula is considered an indicator of an organization’s overall financial health and is used for various reasons by lenders, investors and other business professionals. Lenders calculate a company’s debt ratio to determine the risk of lending them money. Similarly, investors calculate this ratio to determine the risk and/or potential reward of investing in a company. Since a debt ratio is also an indicator of a company’s ability to leverage funds, it indicates the potential for increased borrowing, which could be used to generate greater returns, making it an attractive option for potential investors.
How to calculate debt ratio
In addition to understanding what the debt ratio formula is and why it is relevant for investors, lenders and business owners, it is important to understand how to calculate it. Here are the three steps to calculate a debt ratio:
1. Total a company’s debts
To total a company’s debts, you combine all of its short- and long-term liabilities into a single sum. If you have access to the company’s latest financial report, this information will be included on its balance sheet, which can save you time when performing the calculations.
2. Total a company’s assets
To total a company’s assets, you combine all of its tangible and intangible assets into a single sum. Tangible refers to physical items such as product inventory or real estate. Intangible refers to cash and investments. This information can also be found on a financial report’s balance sheet.
3. Divide the total debts by the total assets and convert them to a percentage
Dividing the company’s total debts by its total assets will give you a decimal number between zero and one. Multiplying that number by 100 will convert it to a percentage, which is the form by which most people reference it.
How to interpret debt ratio results
As it relates to risk for lenders and investors, a debt ratio at or below 0.4 or 40% is considered low. This indicates minimal risk, potential longevity and strong financial health for a company. Conversely, a debt ratio above 0.6 or 0.7 (60-70%) is considered a higher risk and may discourage investment. The highest possible ratio is 1.0, which indicates that a company would have to sell all of its assets to cover its debts.
In addition to the raw score, lenders and investors consider a company’s credit and payment history when making investment decisions. Specifically, a strong credit and payment history might offset the perceived risk for a prospective lender. The industry context for a given company is also a factor. Certain industries are considered capital intensive, meaning they require substantial front-end spending to produce a good or service and thus maintain high debt ratios. This includes airlines, telecommunications and utility companies. Comparing a specific company’s ratio to that of comparable competitors provides more complete context for a prospective lender or investor.
Debt ratio example
When deciding whether or not to loan money, potential lenders consider a company’s current debt ratio and what the debt ratio would be if the loan in question were approved. Here is an example of how to calculate the debt ratio for a hypothetical company seeking a new loan:
A family-owned and operated ice cream business wants to expand to open a second location in the New York City area in the upcoming year. This company currently has $15,000 in short term liabilities and $125,000 in long term liabilities, making their total debts equal to $140,000. To open the second location, they are applying for a $200,000 loan to cover modest store renovations, specialized equipment and rent for the first six months of operations. If approved, the company’s debt payment would be $5,000, making their total debts equal to $145,000.
This company also has $110,000 of tangible assets, mostly in the form of equipment, and $45,000 of intangible assets for a total of $155,000 in assets. This company’s debt ratio is $145,000 divided by $155,000, which is 0.93 or 93%. This falls just shy of the highest possible ratio of 1.0.
Although a ratio this high would typically discourage lenders from approving the loan, the capital-intensive nature of this industry and uniquely-high operating costs for this geographic area may offset that number. Specifically, a homemade ice cream business will require specialized machinery and materials that result in elevated start-up costs. If marketed strategically, however, they will be able to charge higher prices for their custom product than a chain ice cream business could. Similarly, New York City businesses charge higher prices than similar retailers in other locations to account for the higher rent and related costs.
In a situation like this, the prospective lender could choose to consider the company’s credit or payment history as an additional determining factor in their decision making. Essentially, they would have to determine whether or not the unique context for this business and location justify the financial risk of lending to a company with a high debt ratio.