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Debt ratio definition

Description

The debt ratio (debt to assets) is used to compare company's total debt to its total assets. This measure shows the proportion of assets, bought from borrowed funds. Data to calculate this ratio is collected from balance sheet.

The debt ratio is used while analyzing company’s capital structure. This ratio is used to evaluate company's financial risk, because the more funds the company is borrowing, the greater business risk appears. Debt ratio is similar to debt to equity ratio.

Norms and limitations

If a debt ratio is higher than 1 it indicates that a company has more debt that assets. If this ratio is lower than 1, the level of assets is higher than debt within the company.

To make things clearer, it is worth mentioning that the higher the ratio is, the greater financial risk the company is facing. The value of debt ratio is highly dependent on the industry that the company is operating in.

Formula

Debt (total debt, total liabilities) is calculated by adding together the long term debt with the short term debt. These two measures can be easily located on the balance sheet.

Assets (Total assets) – every asset that company owns and which is shown on the balance sheet. Total assets equal total liabilities + owner’s equity.