Total Debt-to-Total Assets Ratio: Meaning, Formula, and What’s Good

how to calculate debt ratio

Total debt-to-total assets is a measure of the company’s assets that are financed by debt rather than equity. If the calculation yields a result greater than 1, this means the company is technically insolvent as it has more liabilities than all of its assets combined. A result of 0.5 (or 50%) means that 50% of the company’s assets are financed using debt (with the other half being financed through equity). It is a measurement of how much of a company’s assets are financed by debt; in other words, its financial leverage. The debt ratio focuses exclusively on the relationship between total debt and total assets.

  1. The concept of comparing total assets to total debt also relates to entities that may not be businesses.
  2. Let’s look at a few examples from different industries to contextualize the debt ratio.
  3. A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation.
  4. Thus, it is very important to be certain the correct values are used in the calculation, so the ratio does not become distorted.

Debt to Equity Ratio (D/E)

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. Therefore, the company had more debt ($18.2 billion) on its books than all of its $15.7 xero order management billion current assets (assets that can be quickly converted to cash). For information pertaining to the registration status of 11 Financial, please contact the state securities regulators for those states in which 11 Financial maintains a registration filing.

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how to calculate debt ratio

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how to calculate debt ratio

In contrast, the payment of dividends to equity holders is not mandatory; it is made only upon the decision of the company’s board. A company that has a debt ratio of more than 50% is known as a “leveraged” company. The debt-to-equity ratio (D/E) compares the total debt balance on a company’s balance sheet to the value of its total shareholders’ equity. Some sources consider the debt ratio to be total liabilities divided by total assets. This reflects a certain ambiguity between the terms debt and liabilities that depends on the circumstance. The debt-to-equity ratio, for example, is closely related to and more common than the debt ratio, instead, using total liabilities as the numerator.

Banks carry higher amounts of debt because they own substantial fixed assets in the form of branch networks. Higher D/E ratios can also tend to predominate in other capital-intensive sectors heavily reliant on debt financing, such as airlines and industrials. 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.

Companies in some industries, such as utilities, consumer staples, and banking, typically have relatively high D/E ratios. Debt-financed growth may serve to increase earnings, and if the incremental profit increase exceeds the related rise in debt service costs, then shareholders should expect to benefit. However, if the additional cost of debt financing outweighs the additional income that it generates, then the share price may drop. The cost of debt and a company’s ability to service it can vary with market conditions. As a result, borrowing that seemed prudent at first can prove unprofitable later under different circumstances. Suppose a company carries $200 million in total debt and $100 million in shareholders’ equity per its balance sheet.

Last, businesses in the same industry can be contrasted using their debt ratios. 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. So if a company has total assets of $100 million and total debt of $30 million, its debt ratio is 0.3 or 30%. Is this company in a better financial situation than one with a debt ratio of 40%? The total debt-to-total-asset ratio is calculated by dividing a company’s total debts by its total assets.

The debt ratio is a financial leverage ratio that measures the portion of company resources (pertaining to assets) that is funded by debt (pertaining to liabilities). What counts as a good debt ratio will depend on the nature of the business and its industry. Generally speaking, a debt-to-equity or debt-to-assets ratio below 1.0 would be seen as relatively safe, whereas ratios of 2.0 or higher would be considered risky. Some industries, such as banking, are known for having much higher debt-to-equity ratios than others. 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.

This understanding is crucial for investors and analysts to ascertain a company’s financing strategy. In a low-interest-rate environment, borrowing can be relatively cheap, prompting companies to take on more debt to finance expansion or other corporate initiatives. Different industries have varying levels of capital requirements, operational risks, and profitability margins. The sum of all these obligations provides an encompassing view of the company’s total financial obligations.

By contrast, higher D/E ratios imply the company’s operations depend more on debt capital – which means creditors have greater claims on the assets of the company in a liquidation scenario. The formula for calculating the debt-to-equity ratio (D/E) is equal to the total debt divided by total shareholders equity. The periods and interest rates of various debts may differ, which can have a substantial effect on a company’s financial stability.

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. A company with a high degree of leverage may thus find it more difficult to stay afloat during a recession than one with low leverage.