The total debt ratio, more often called debt ratio, is a measure of a company's debt leverage and helps you indicate much a company funds itself with debt. If your company needs to borrow some additional money, this ratio is useful as an indicator of how risky lenders will see your company, since lenders use the debt ratio along with other company financial information to determine if lending money makes financial sense. To calculate the figure, you simply use the debt ratio equation where you divide the total liabilities for the business at a given moment by the total assets.
TL;DR (Too Long; Didn't Read)
How to calculate debt ratio- divide total liabilities by total assets (total liabilities/ total assets). a company should maintain a debt ratio no higher than 60 to 70 percent.
Identify Total Liabilities
To calculate total liabilities, add the short-term and long-term liabilities together. If short-term liabilities are $60,000 and long-term liabilities are $140,000, for instance, total liabilities equal $200,000. If short-term liabilities are $30,000 and long-term liabilities are $70,000, total liabilities equal $100,000. If a financial report has already been prepared for a given period, you can also look at the total liabilities amount reported on the balance sheet.
Identify Total Assets
The debt ratio shows how much debt the business carries relative to its assets. To calculate total assets at a given point, add together the company's current assets, investments, intangible assets, property, plant and equipment and other assets. If current assets are $75,000 and investments and all other assets total $225,000, your total assets equal $300,000. A prepared balance sheet typically reports the final amount of total assets at a particular point.
Divide Total Liabilities by Total Assets
After you have the numbers for both total liabilities and total assets, you can plug those values into the debt ratio formula, which is total liabilities divided by total assets. If total liabilities equal $100,000 and total assets equal $300,000, the result is 0.33. Expressed as a percentage, the total debt ratio is 33 percent. Alternatively, if total debt equals $200,000 and total assets equal $300,000, the result is 0.667 or 67 percent.
Interpret the Total Debt Ratio
Typically, a company should maintain a debt ratio no higher than 60 to 70 percent, according to financial reporting software provider Ready Ratios. A ratio higher than this suggests the company is highly debt leveraged, which makes it difficult to keep up with near-term and long-term debt payments. When the debt ratio is below 50 percent, the company finances a larger portion of its assets through equity. When the debt ratio is above 50 percent, debt finances more than half of assets.
If your debt ratio is over 100 percent, lenders will see it as too risky to lend to your company since you have a higher level of debt than you do assets. Likewise, investors may not find your company attractive due to the high leverage.
- Drazen_/iStock/Getty Images