Debt Ratio
Debt Ratio
The Debt Ratio is a financial formula within the family of Leverage Ratios . It takes two numbers from your company’s balance sheet — total debt and total assets — and divides them. This produces a number that tells you the proportion of your business’ assets that are financed by debt.
Debt Ratio Formula:
Debt Ratio = total debt / total assets
Helpful Definitions:
Total debt: Total debt is found on your company’s balance sheet. It is all long-term loans and short-term liabilities added together.
Total assets: Total assets is the sum of all cash stores, accounts receivable, inventory, equipment, and anything else of value owned by your business. It can be calculated from your balance sheet by adding together fixed and current assets.
Balance sheet: A core financial statement that records a snapshot of a company’s assets, liabilities, and equity at the time of publication. For more information about the Balance Sheet, read our helpful blog post !
What can the debt ratio tell me about my business?
The debt ratio tells you the proportion of your company’s assets that are financed by debt, and indicates how leveraged your company currently is. It may be expressed as a decimal or percentage.
A debt ratio of exactly one (or 100%) means that you have equal amounts of debt and assets.
A number under one — such as .5, or 50% — means that half of your total assets are financed by debt. Banks and other lenders look favorably on lower debt ratios, as these indicate that the company is in a better position to pay off its obligations.
A ratio over one means your business currently holds more debt than assets, and you have negative equity. In this scenario, you may be at risk of defaulting on loans, or going bankrupt.
A higher debt ratio means your company is more leveraged, and taking on greater financial risk. However, leveraging is an important aspect of company growth, and too low of a debt ratio may indicate that a business owner is playing things too safely.
Debt ratios vary widely depending on the business model of the company. A business with greater variability in cash flow may keep an extremely low debt ratio to mitigate risk. Comparing your debt ratio to the ratio of companies of a similar size within your industry can give you a sense of whether or not you are within the average.