Debt Ratio
Debt Ratio
Debt Ratio
• defined as the ratio of total debt to total assets, expressed in percentage, and can be interpreted as the proportion of a company’s assets that are financed by debt. • Measures the proportion of total assets financed by the firm’s creditors. The higher this ratio, the greater amount of other people’s money being used to generate profits.
Formula:
• The debt ratio is calculated by dividing total debt by total assets. Debt Ratio
=
Total Debt
Total Assets
Examples
• Dave's Guitar Shop is thinking about building an addition onto the back of its existing building for more storage. Dave consults with his banker about applying for a new loan. The bank asks for Dave's balance to examine his overall debt levels.
• The banker discovers that Dave has total assets of $100,000 and total liabilities of $25,000. Dave's debt ratio would be calculated like this:
Total liabilities include both the current and non-current liabilities.
• Example 2: Current liabilities are $34,600; Non-current liabilities are $200,000; and Total assets are $504,100.
Calculate debt ratio.
• Solution
Since total liabilities are equal to sum of current and noncurrent liabilities therefore,
Debt Ratio = ($34,600 + $200,000) / $504,100 = 0.465 or
46.5%.
Analysis
• The debt ratio is shown in decimal format because it calculates total liabilities as a percentage of total
•
•
•
•
assets. As with many solvency ratios, a lower ratios is more favorable than a higher ratio.
A lower debt ratio usually implies a more stable business with the potential of longevity because a company with lower ratio also has lower overall debt. Each industry has its own benchmarks for debt, but .
5 is reasonable ratio.
A debt ratio of .5 is often considered to be less risky. This means that the company has twice as many assets as liabilities. Or said a different way, this company's liabilities are only 50 percent of its total assets.
Essentially, only its creditors own half of the company's
Debt Ratio
• defined as the ratio of total debt to total assets, expressed in percentage, and can be interpreted as the proportion of a company’s assets that are financed by debt. • Measures the proportion of total assets financed by the firm’s creditors. The higher this ratio, the greater amount of other people’s money being used to generate profits.
Formula:
• The debt ratio is calculated by dividing total debt by total assets. Debt Ratio
=
Total Debt
Total Assets
Examples
• Dave's Guitar Shop is thinking about building an addition onto the back of its existing building for more storage. Dave consults with his banker about applying for a new loan. The bank asks for Dave's balance to examine his overall debt levels.
• The banker discovers that Dave has total assets of $100,000 and total liabilities of $25,000. Dave's debt ratio would be calculated like this:
Total liabilities include both the current and non-current liabilities.
• Example 2: Current liabilities are $34,600; Non-current liabilities are $200,000; and Total assets are $504,100.
Calculate debt ratio.
• Solution
Since total liabilities are equal to sum of current and noncurrent liabilities therefore,
Debt Ratio = ($34,600 + $200,000) / $504,100 = 0.465 or
46.5%.
Analysis
• The debt ratio is shown in decimal format because it calculates total liabilities as a percentage of total
•
•
•
•
assets. As with many solvency ratios, a lower ratios is more favorable than a higher ratio.
A lower debt ratio usually implies a more stable business with the potential of longevity because a company with lower ratio also has lower overall debt. Each industry has its own benchmarks for debt, but .
5 is reasonable ratio.
A debt ratio of .5 is often considered to be less risky. This means that the company has twice as many assets as liabilities. Or said a different way, this company's liabilities are only 50 percent of its total assets.
Essentially, only its creditors own half of the company's