Borrowing money to support a business operation is common. A company can often run more efficiently using loans and lines of credit to smooth out cash flow. However, a business can rely too heavily on financing. The debt-to-assets ratio helps establish how a company is performing by comparing borrowing to equity.
Debt-to-Asset Ratio Calculation
Calculating the debt-to-asset ratio is simply a matter of dividing the amount of money a company has borrowed by the assets it controls. These may be things such as equipment, real estate and cash. For example, Company A borrows $750,000, and has $500,000 in assets, for a debt-to-asset ratio of 1.5-to-1. Company B borrows $250,000 against $500,000 in assets, for a ratio of 0.5-to-1. Debt-to-asset ratio is often called simply the debt ratio, and it is occasionally expressed as a percentage by multiplying the first number by 100.
Analyzing Debt-to-Asset Ratio
Low debt-to-asset ratios indicate less dependence on loans to run a business. Bankers will look at a company's total assets as a resource for repaying loans, so high ratios may make it difficult for a company to borrow. Similarly, investors or buyers may see high ratios as a warning sign about the condition of a company's stock or purchase price.
Debt-to-asset ratio is a measure of how a business uses financial leverage in its operations. For example, a company that is completely funded by its owner uses no leverage at all. When a company borrows money to increase its assets, it is using debt as leverage. Accounting training website Accounting Coach.com illustrates how leverage can increase a company's return on investment when company assets rise, while potential losses grow when assets decline in value, compared with a company with little or no borrowing.
Average debt-to-asset ratios vary by industry and company size. Large companies with stable cash flow often have higher ratios, while businesses in more volatile industries operate with less debt and lower ratios. Business analysis company CSIMarket.com shows very low debt-to-asset ratios for technology companies such as Facebook, at 0.11 and Google at 0.25. With entirely different business models, retailers Walgreens and Wal-Mart have ratios of 1.36 and 1.63, respectively.
A full-time content creation freelancer for over 12 years, Scott Shpak is a writer, photographer and musician, with a past career in business with Kodak.