Debt Ratio

Debt Ratio

Good debt is a powerful tool, but bad debt can kill you. – Robert Kiyosaki

What is the debt ratio?

Measures the use of debt to finance a company.

How is the debt ratio calculated?

Debt ratio = total debt / total assets.  Total debt includes all debts owed by a business; total assets includes all assets owned by a business.  

What does the debt ratio mean to my business?  

A debt ratio that is greater than one means that the company carries more debt than assets.  Said another way, the company has negative equity (or a deficit).  Not only is the company entirely financed by its lender, it could be putting itself at risk of defaulting on loans.  A lender is less likely to lend to a company with a high debt ratio, which represents an aggressive company structure.     

A debt ratio that is less than one means that the company is partially funded by equity (or the business owner’s funds). The closer this number is to zero the greater the proportion of equity funding, which represents a more conservative company structure.  

Negatives to the debt ratio:
By itself, the debt ratio expresses the percentage of the company or business that is financed by debt.  It falls short of evaluating the effective (or ineffective) use of debt, which is where the interest coverage ratio comes in.