Posted by Debt Ratio is a also known as debt to asset ratio is leverage ratio or solvency ratio. Debt ratio is a financial ratio used to determine how much percentage of business’s assets are financed through debt. The Debt ratio can be calculated by dividing total debts by total assets. Investors and analysts use this ratio to determine financial leverage of a company.
Debt Ratio –
Debt to Asset ratio = Total Debt / Total Assets
We can get this data of total debt and total assets from balance sheet. Total debt includes short term debt as well as long term debt and total assets includes short term assets as well as long term assets.
Debt to asset ratio varies sector to sector, so whenever we use this ratio for analysis always remember to compare this ratio with the companies within the same sector.
Lets take examples,
Above table shows the examples of debt ratio, as we know we can calculate total debt by using formula,
Total Debt = Short Term Debt + Long Term Debt
Also we can calculate total assets by using formula,
Total Assets = Short Term Asset + Long Term Asset
We know the formula for debt to asset ratio is
Debt to Asset Ratio = Total Debt / Total Assets
COMPANY A –
Now lets calculate debt to asset ratio for company A, total debt = 130 and total assets = 530, so debt to asset ratio of company A is
Debt to Asset ratio of company A = Total Debt of company A / Total Asset of company A
Debt to Asset ratio of company A = 130 / 530
Debt to Asset ratio of company A = 0.25
The debt to asset ratio of company A is 0.25 which suggests company has more assets than liabilities or debt. Debt ratio of 0.25 shows company is financially stable and low risky to invest and it also means most of the assets are fully owned by company.
COMPANY B –
Now lets calculate debt to asset ratio for company B, total debt = 185 and total assets = 185, so debt to asset ratio of company B is
Debt to Asset ratio of company B = Total Debt of company B / Total Asset of company B
Debt to Asset ratio of company B = 185 / 185
Debt to Asset ratio of company B = 1.00
The debt to asset ratio of company B is 1 which suggests that company owns same amount of debt as its assets. Debt ratio of 1 shows that company is highly leveraged and highly risky to invest.
COMPANY C –
Now lets calculate debt to asset ratio for company C, total debt = 190 and total assets = 170, so debt to asset ratio of company C is
Debt to Asset ratio of company C = Total Debt of company C / Total Asset of company C
Debt to Asset ratio of company C = 190 / 170
Debt to Asset ratio of company C = 1.12
The debt to asset ratio of company C is 1.12 which suggests company has more debt than its assets. Debt Ratio of 1.12 shows that company is extremely leveraged and very risky to invest.
Normally debt ratio of more than 0.5 indicates high risk.
