Flow of the debt ratio article
Debt Ratio Formula
It is one of the most used solvency ratios by investors. And it’s pretty easy to calculate too.
Let’s have a look at the formula of debt ratio –
All you need to do is to look at the balance sheet and find out whether a firm has enough total assets to pay off its total liabilities.
Explanation of Debt Ratio Formula
For an investor, the financial statements are everything. They look at all four financial statements and make their judgments. One of the most important financial statements is balance sheet. By looking at the balance sheet, the investors are able to know what’s working for a company and what needs to be improved.
Two of the most important items on the balance sheet are assets and liabilities. By looking at the total assets and the total liabilities, the investors are able to understand whether the firm has enough assets to pay off the liabilities. And that’s exactly what we call debt ratio.
By using this ratio, we calculate the proportion of the total assets and the total liabilities. And by looking at them, we get to know the stance of a company at any stage.
Use of Debt Ratio Formula
This ratio is useful for two groups of people.
- The first group is the top management of the company who is directly responsible for the expansion or contraction of a company. By using this ratio, the top management sees whether the company has enough resources to pay off its obligations.
- The second group is the investors who would like to see the position of a company before they ever put in their money into the company. That’s why the investors need to know whether the firm has enough assets to bear the expenses of debts and other obligations.
This ratio also measures the financial leverage of the company. And it also tells the investors how leveraged the firm is. If the firm has a higher level of liabilities compared to assets, then the firm has more financial leverage and vice versa.
Example of Debt Ratio Formula
Let’s take a practical example to illustrate this ratio.
Boom Company has the following details –
- Current Assets – $30,000
- Non-current Assets – $300,000
- Current Liabilities – $40,000
- Non-current Liabilities – $70,000
Find out the debt ratio of Boom Company.
In the above example, we can see that we need to total the current and non-current assets and also current liabilities and non-current liabilities.
- The total assets are = (Current Assets + Non-current Assets) = ($30,000 + $300,000) = $330,000.
- The total liabilities are = (Current Liabilities + Non-current Liabilities) = ($40,000 + $70,000) = $110,000.
- Debt ratio formula is = Total Liabilities / Total Assets = $110,000 / $330,000 = 1/3 = 0.33.
- Ratio of Boom Company is 0.33.
To know whether this proportion between total liabilities and total assets is healthy or not, we need to see the similar companies under same industry. If the ratio of those companies is also in the similar range, it means Boom Company is doing quite well.
In normal situations, as lower as this ratio can be; better it is in terms of investment and solvency.
Debt Ratio Calculator
You can use the following Debt Ratio Calculator
|Debt Ratio Formula =||
Debt Ratio in Excel (with excel template)
Let us now do the same example above in Excel.
This is very simple. You need to provide the two inputs of Total Liabilities and Total Assets.
You can easily calculate the ratio in the template provided.
You can download this Debt ratio template here – Debt Ratio Excel Template
This has been a guide to Debt Ratio Formula, practical examples and debt ratio calculator along with excel templates. You may also have a look at these articles below to learn more about Financial Analysis –
- Leverage Ratios
- Capitalization Ratio Formula
- DSCR Ratio
- Days Payable Outstanding
- Days Sales Outstanding