Debt to Asset Ratio and FormulaHow to Calculate with Examples
The debt to asset ratio, which is also sometimes called the debt ratio, is the ratio of a company’s total debt to its total assets.
This ratio is a leverage ratio that indicates a company’s ability to support its current debt and take on additional debt if it needs to.
If a company has a high debt to asset ratio, it is more highly leveraged and at greater financial risk.
Creditors often use the debt ratio to find out how much debt a business has, whether it will be able to pay its debts, and if it will make more loans to the business.
For investors, the ratio is useful for determining whether or not a business is solvent and likely to produce a return on their investment.
The Formula for Debt to Asset Ratio
The debt ratio formula is:
(Short-term Debt + Long-term Debt) / Total Assets
The total assets in the above formula may consist of all of the non-current and current assets that the company lists on its balance sheet.
Although, it could consist of only specific assets, such as PP&E (property, plant, and equipment).
It depends on what the analyst chooses to include.
Example
We will use the following balance sheet to compute the debt ratio.
| Balance Sheet | |
| Assets | |
| Cash | $50,000 |
| Accounts Receivable | $80,000 |
| Supplies | $15,000 |
| Inventory | $40,000 |
| Equipment | $35,000 |
| Total Assets $220,000 | |
| Liabilities | |
| Accounts Payable | $15,000 |
| Notes Payable | $30,000 |
| Total Liabilities | $45,000 |
| Stockholders’ Equity | |
| Common Stock | $135,000 |
| Retained Earnings | $40,000 |
| Stockholders’ Equity | $175,000 |
| Total Liabilities and Stockholders’ Equity | |
This balance sheet shows total assets of $220,000 and total debt of $45,000.
So, the debt to assets ratio is 20%.
The calculation is shown below.
Debt to Asset Ratio = $45,000 / $220,000 = .2045 = 20%
This means that 20% of the company is owned by creditors.
Understanding the Debt Ratio
It is good to understand the debt ratio as it is often used by investors, creditors, and analysts to assess the amount of debt a company has as well as its ability to meet its obligations in the future.
It is considered better for a company to have a lower debt to asset ratio.
A high ratio is an indication that a company is more highly leveraged and thus is more of a risk for investment for investors and riskier for banks to give loans to.
Should this ratio continually increase, the company could default.
If a company has a debt ratio that is greater than 1, it has more liabilities than assets.
Therefore, it would be very risky for a financial institution to loan money to this company or for investors to make an investment in the company.
If a business has a debt ratio of 1, its liabilities are equal to its assets.
This shows the business is highly leveraged.
A business that has a debt ratio that is below one has more assets than it does liabilities.
Therefore, the business has sufficient assets to allow it to pay its debts by liquidating its assets if necessary.
Final Thoughts
The debt to asset ratio is a good way to help analyze the financial risk of a business.
A lower debt ratio indicates the business has more assets than debts and should be able to meet its obligations.
In contrast, a high debt ratio means that a large number of a company’s assets are funded through debt.
This puts a company at an increased risk of default. When using this ratio, it is best to look at it over time to see if it is increasing or decreasing.
This can give an investor or creditor a better idea of the company’s direction.
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Michigan State University "Financial Ratios Part 4 of 21: Debt-To-Asset Ratio" Page 1 . July 27, 2022
Iowa State University "Financial Ratios" Page 1 . July 27, 2022