What is Debt Ratio
Debt ratio is a financial ratio that measures the company’s debt compared to the company’s assets. The debt ratio is used to indicate the percentage of assets that are being financed with debt. An interpretation of the debt ratio represents the proportion of borrowed funds used to acquire all the company’s assets.
The debt ratio is a comparison between the total debt and total assets of a company. It can be calculated by dividing the total debt by the total assets. The lower debt to asset ratio, the lower company’s debt compared to the company’s assets. The higher the ratio, the higher degree of leverage and financial risk.
Therefore, when the debt ratio is higher than 1 means the company had higher total debt than the total assets.
Investors use the debt ratio to make sure the company they invest in or want to invest in is solvent. Solvency is a company’s ability to pay its debts when they are due. In other words, to survive in the long run. This is the reason why long-term debt creditors and shareholders care about this ability.
Debt Ratio Formula
The debt ratio can be computed by dividing the total debt by the total assets, or the following debt ratio formula:
Debt Ratio = Total Debt / Total Assets
The debt ratio is also known as the debt to asset ratio (D/A).
Let’s say the Feriors company had the following financial results:
- Total debt of $100
- Total assets of $200
Debt Ratio = 100 / 200 = 0.5 (or 50%)
From the example above, the company had total debt of 50% of the total assets.
Frequently Asked Questions
The debt ratio is a financial ratio that measures the company’s debt compared to the company’s assets. The debt ratio is used to indicate the percentage of assets that are being financed with debt.
The debt ratio can be computed by dividing the total debt by the total assets, or the following formula: Debt Ratio = Total Debt / Total Assets
