Debt Ratio Formula Example Analysis

The calculation includes long-term and short-term debt (borrowings maturing within one year) of the company. The debt ratio calculation is done by simply dividing the total debt (liabilities) by the total assets. The total debts of the company include all its short and long-term liabilities such as lines of credit, bank loans, etc.

Is a Low Total Debt-to-Total Asset Ratio Good?

In contrast, the payment of dividends to equity holders is not mandatory; it is made only upon the decision of the company’s board. The higher the debt ratio, the more leveraged a company is, implying greater financial risk. At the same time, leverage is an important tool that companies use to grow, and many businesses find sustainable uses for debt. In the consumer lending and mortgage business, two common debt ratios used to assess a borrower’s ability to repay a loan or mortgage are the gross debt service ratio and the total debt service ratio. A high debt-equity ratio can be good because it shows that a firm can easily service its debt obligations (through cash flow) and is using the leverage to increase equity returns.

Debt Ratio vs. Long-Term Debt to Asset Ratio

Additionally, the debt-to-capital ratio does not take cash flow into account. Short-term debt also increases a company’s leverage, of course, but because these liabilities must be paid in a year or less, they aren’t as risky. In conclusion, among the 3 companies compared, Hertz has the lowest degree of flexibility as it has legal obligations to fulfill.

Debt to Equity Ratio Calculator

Calculate the debt ratio if the company had total assets of $14.37 billion. Since the debt to asset ratio shows the overall debt burden of the company, the income taxes payable uses the total liabilities and the total assets, and not just the current debt. The ratio is shown in decimal format because it calculates total liabilities as a percentage of total assets.

What is the formula for the debt-to-capital ratio?

Additionally, a high debt to assets ratio may indicate that the company has low borrowing capacity, which in turn will lower the financial flexibility of the company. Furthermore, the debt ratio of a company, like all financial ratios should be compared with its industry average or other competing companies. Let’s say you recently ventured into a startup company and have borrowed funds from a bank as a personal loan. The bank has determined that your business has total assets of 50,000$  and total liabilities of 5,000$.

The D/E Ratio for Personal Finances

The ratio for both firms has stayed in a narrow range of 13-15% over the four-year period indicating little change in solvency of the companies. Too little debt and a company may not be utilizing debt in a healthy way to grow its business. Understanding the debt ratio within a specific context can help analysts and investors determine a good investment from a bad one.

What is a Good Debt to Asset Ratio?

In contrast, poorly performing companies often need to keep taking on debt to support unproductive investments that don’t generate the earnings and cash flow to be reinvested in high-return investments. This scenario often leads to more debt taken on board and a rising debt ratio. So in a sense, monitoring the debt ratio is a handy guide to the company’s ongoing performance. For example, if a company’s debt ratio keeps rising over time, it implies that it needs to take on debt to buy assets to fuel growth. Therefore, comparing a company’s debt to its total assets is akin to comparing the company’s debt balance to its funding sources, i.e. liabilities and equity. A company can improve its debt ratio by cutting costs, increasing revenues, refinancing its debt at lower interest rates, improving cash flows, increasing equity financing, and possibly restructuring.

1. As a result, drawing conclusions purely based on historical debt ratios without taking into account future predictions may mislead analysts.
2. But before that, let’s prepare ourselves for the process of deciphering the implications of different debt ratios.
3. A company with a high debt ratio may still be financially healthy if it is generating strong profits and has sufficient cash flow to service its debt obligations.

Gearing ratios focus more heavily on the concept of leverage than other ratios used in accounting or investment analysis. The underlying principle generally assumes that some leverage is good, but that too much places an organization at risk. Gearing ratios constitute a broad category of financial ratios, of which the D/E ratio is the best known. https://www.business-accounting.net/ We can see below that for Q1 2024, ending Dec. 30, 2023, Apple had total liabilities of $279 billion and total shareholders’ equity of $74 billion. This means that when using the debt ratio, in order to get an accurate debt ratio analysis, financial managers and business managers have to make use of good judgment and look beyond the numbers.

A higher debt ratio (0.6 or higher) makes it more difficult to borrow money. Lenders often have debt ratio limits and do not extend further credit to firms that are overleveraged. Of course, there are other factors as well, such as creditworthiness, payment history, and professional relationships. For example, in the example above, Hertz reported $2.9 billion in intangible assets, $1.3 billion in PPE, and $1.04 billion in goodwill as part of its total $20.9 billion of assets.

In most cases, this would be considered a sign of high risk and an incentive to seek bankruptcy protection. What counts as a “good” debt-to-equity (D/E) ratio will depend on the nature of the business and its industry. Generally speaking, a D/E ratio below 1 would be seen as relatively safe, whereas values of 2 or higher might be considered risky.

As a result, drawing conclusions purely based on historical debt ratios without taking into account future predictions may mislead analysts. If its assets provide large earnings, a highly leveraged corporation may have a low debt ratio, making it less hazardous. Contrarily, if the company’s assets yield low returns, a low debt ratio does not automatically translate into profitability.

It offers a comparison point to determine whether a company’s debt levels are higher or lower than those of its competitors. As is the story with most financial ratios, you can take the calculation and compare it over time, against competitors, or against benchmarks to truly extract the most valuable information from the ratio. The debt-to-capital ratio is calculated by dividing a company’s total debt by its total capital, which is total debt plus total shareholders’ equity.

Depending on averages for the industry, there could be a higher risk of investing in that company compared to another. This is a relatively low ratio and implies that Dave will be able to pay back his loan. Tune in for the next section where we discuss the risks and benefits of varying debt ratios. Stakeholders, especially creditors, may view a high debt ratio as an increased risk, potentially impacting the company’s borrowing costs and terms. A low debt ratio, typically less than 0.5 or 50%, indicates that a company relies more on equity than on borrowed funds to finance its assets. The debt ratio is the ratio of a company’s debts to its assets, arrived at by dividing the sum of all its liabilities by the sum of all its assets.