Debt Ratio Definition
Define Debt Ratio In Simple Terms
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.
It is a measurement of how much of a company’s assets are financed by debt; in other words, its financial leverage.
If the ratio is above 1, it shows that a company has more debts than assets, and may be at a greater risk of default.
Debt Ratio Formula
To find a business’ debt ratio, divide the total debts of the business by the total assets of the business.
Check out the debt ratio equation:
What Does Debt Ratio Mean In Finance?
The purpose of calculating the debt ratio of a company is to give investors an idea of the company’s financial situation.
Too high a debt ratio can indicate a looming problem for a company. At the very least, a company with a high amount of debt may have difficulty paying or maintaining dividend payments for investors.
Likewise, too low of a debt ratio could mean that the company in question is underinvesting in assets and stunting their own growth, which could mean that equity shares will be slow to appreciate in value, if at all.
Debt Ratio Example
Debt ratios can vary widely depending on the industry of the company in question.
For example, capital intensive businesses, such as those in the energy sector, generally take on more debt than companies in the IT sector.
Because of this, what is considered to be an acceptable debt ratio by investors may depend on the industry of the company in which they are investing.