Without understanding the sectoral norms and risk profiles, judging a company merely on its debt ratio may be misleading. In conclusion, the figures are just guides—the appropriate debt ratio can vary significantly across industries and companies. To find a business’s debt ratio, divide the total debts of the business by the total assets of the business. Newer businesses or startups might rely heavily on debt financing to kick-start operations, leading to higher debt ratios.

• The calculation includes long-term and short-term debt (borrowings maturing within one year) of the company.
• The formula for the debt ratio is dividing the total debt of the company by the total assets/stocks/equity held by the company/shareholders.
• Since this is less than 1, this is considered a low-risk debt ratio and you may go for that much longed-holiday or even seek financial assistance from a bank to pay for your vacation.
• This represents a blend of debt and equity financing, which may be perceived as a less risky and more sustainable model compared to a high debt ratio.

It indicates how much debt is used to carry a firm’s assets, and how those assets might be used to service debt. To use the debt ratio as a sustainability metric, think of it as a measure of a company’s long-term fiscal responsibility. This takes into account both internal operations and the external economic climate. Lenders, including banks and other credit institutions, often use the debt ratio as a fundamental component in their decision-making process. The reason is simple – this ratio directly indicates the proportion of a business’s total assets that are financed by its lenders.

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Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

• Total-debt-to-total-assets is a leverage ratio that defines how much debt a company owns compared to its assets.
• Companies with strong operating incomes might comfortably manage higher debt loads, while those with weaker incomes might struggle even with lower debt ratios.
• Both the numerator and denominator in this calculation are always positive numbers, so the resulting ratio cannot be negative.
• Businesses with a lower ratio might qualify for more favourable lending terms, such as lower interest rates or longer repayment periods.

It’s also important to understand the size, industry, and goals of each company to interpret their total-debt-to-total-assets. Google is no longer a technology start-up; it is an established company with proven revenue models that is easier to attract investors. Meanwhile, Hertz is a much smaller company that may not be as enticing to shareholders. Hertz may find the demands of investors are too great to secure financing, turning to financial institutions for its capital instead. A ratio greater than 1 shows that a considerable portion of the assets is funded by debt.

Long Term Debt to Total Asset Ratio

The interpretation of this key financial indicator depends heavily on the context and specific circumstances of the company under analysis. At the very least, a company with a high amount of debt may have difficulty paying or maintaining dividend payments for investors. Companies with strong operating incomes might comfortably manage higher debt loads, while those with weaker incomes might struggle even with lower debt ratios. This assessment can be particularly vital for creditors, investors, and other stakeholders when evaluating the financial health of an organization. While this could indicate aggressive financial practices to seize growth opportunities, it might also mean a higher risk of financial distress, especially if cash flows become inconsistent.

Is a Higher or Lower Debt-to-Equity Ratio Better?

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. Debt/EBITDA is one of the common metrics used by the creditors and rating agencies for assessment of defaulting probability on an issued debt. In simple words, it is a method used to quantify and analyze the ability of a company to pay back its debts. This ratio facilitates the investor with the approximate time period required by a firm or business to pay off all debts, ignoring factors like interest, depreciation, taxes, and amortization. You can use the equity and debt aspects to depict the financial position of a company. The debt ratio checks whether a company is dependent on liabilities or equity for running its business.

Factors Influencing Debt Ratio

However, this will also vary depending on the stage of the company’s growth and its industry sector. D/E ratios should always be considered on a relative basis compared to industry peers or to the same company at different points in time. For example, in the example above, Hertz is reporting $2.9 billion of intangible assets, $611 million of PPE, and $1.04 billion of goodwill as part of its total $20.9 billion of assets. Therefore, the company has more debt on its books than all of its current assets. Should all of its debts be called immediately by lenders, the company would be unable to pay all its debt, even if the total-debt-to-total-assets ratio indicates it might be able to.

Cons of Debt Ratio

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It determines how easily a company can pay interest expenses on outstanding debt. If a company’s debt ratio is 1, it means that the company’s total debt is equal to its total assets. Or you could say that if a company wants to repay its debt, it has to sell all its assets. If a company has to pay its debt, it has to sell all its assets, in which case the company can no longer operate. Mr. Narayan has a furniture business and has taken a business loan of 100,000$  and retained earnings of 25,000$, its debt ratio will be 4.