Formula to Calculate Debt Ratio
Debt ratio is the ratio of total debt liabilities of a company to the total assets of the company; this ratio represents the ability of a company to hold the debt and be in a position to repay the debt if necessary on an urgent basis. A company which has a debt liability of $30 million out of $100 million total assets, has a debt ratio of 0.3
It is one of the most used solvency ratiosSolvency RatiosSolvency Ratios are the ratios which are calculated to judge the financial position of the organization from a long-term solvency point of view. These ratios measure the firm’s ability to satisfy its long-term obligations and are closely tracked by investors to understand and appreciate the ability of the business to meet its long-term liabilities and help them in decision making for long-term investment of their funds in the business. 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.
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 the 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 sheetItems On The Balance SheetAssets such as cash, inventories, accounts receivable, investments, prepaid expenses, and fixed assets; liabilities such as long-term debt, short-term debt, Accounts payable, and so on are all included in 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.
Let’s take a practical example to illustrate this formula of debt 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 AssetsNon-current AssetsNon-current assets are long-term assets bought to use in the business, and their benefits are likely to accrue for many years. These Assets reveal information about the company's investing activities and can be tangible or intangible. Examples include property, plant, equipment, land & building, bonds and stocks, patents, trademark.) = ($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.
- The 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 similar companies under the same industry. If the ratio of those companies is also in a 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.
Use of Debt Ratio Formula
This formula of debt ratio is useful for two groups of people.
- The first group is the top management of the company, which 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 companyFinancial Leverage Of The CompanyFinancial Leverage Ratio measures the impact of debt on the Company’s overall profitability. Moreover, high & low ratio implies high & low fixed business investment cost, respectively. . 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.
Debt Ratio Calculator
You can use the following Debt Ratio Calculator
|Debt Ratio Formula =||
Calculate Debt Ratio in Excel (with excel template)
Let us now do the same example above in Excel.
It is very simple. You need to provide the two inputs of Total Liabilities and Total Assets.
You can easily calculate the ratio by using the formula of the debt ratio in the template provided.
You can download this Debt ratio template here – Debt Ratio Excel Template.
Debt Ratio Video
This article 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 –