Debt to Asset Ratio Menaing
Debt to asset ratio is the ratio of the total debt of a company to the total assets of the company; this ratio represents the ability of a company to have the debt and also raise additional debt if necessary for the operations of the company. A company which has a total debt of $20 million out of $100 million total asset, has a ratio of 0.2
Debt to Asset Ratio Formula
Debt to asset indicates what proportion of a company’s assets are being financed with debt, rather than equity. The ratio basically helps in the assessment of the percentage of assets that are being funded by debt is-à-vis the percentage of assets that are being funded by the investors. The formula is derived by dividing the aggregate of all short term and long term debts (total debts) by the aggregate of all current assets and non-current assets (total assets).
Mathematically, it is represented as,
Explanation
Step 1: Firstly, the total debts of a company is computed by adding all the short term debts and long term debts that can be gathered from the liability side of the balance sheet.
Total debts = Total short term debts + Total long term debts
Step 2: Next, the total assets of the company can be computed by adding all the current assets and non-current assets that can be gathered from the asset side of the balance sheet.
Total assets = Total current assets + Total non-current assets
Step 3: Finally, the formula of debt to asset ratio can be derived by dividing the total debts (step 1) by the total assets (step 2).
Examples
Let’s see some simple to advanced examples to understand it better.
Example #1
Let us take the example of a company called ABC Ltd which is an automotive repair shop in Brazil. The company has been sanctioned a loan to build out a new facility that is part of its current expansion plan. Currently, ABC Ltd has $80 million in non-current assets, $40 million in current assets, $35 million in short term debt, $15 million in long term debt and $70 million in stockholders’ equity. Calculate the debt to asset for ABC Ltd.
As per the question,
Total debts
- Total debts = Short term debts + Long term debts
- = $35 million + $15 million
- = $50 million
Total Assets
- Total assets = Current assets + Non-current assets
- = $40 million + $80 million
- = $120 million
Therefore, the calculation of debt to total asset ratio formula is as follows –
- Debt to Asset = $50 million / $120 million
Ratio will be –
- Debt to Asset = 0.4167
Therefore, it can be said that 41.67% of the total assets of ABC Ltd is being funded by debt.
Example #2
Let us take an example of Apple Inc. and do the calculation of debt to asset ratio in 2017 and 2018 based on the following information.
Total Assets in 2017
- Total assets in 2017 = Total current assets + Total non-current assets
- = $128,645 Mn + $246,674 Mn
- = $375,319 Mn
Total Assets in 2018
- Total assets in 2018 = $131,339 Mn +$234,386 Mn
- = $365,725 Mn
Total Debts in 2017
- Total debts in 2017 = Commercial paper + Term debt (current portion) + Term debt (non-current portion)
- = $11,977Mn + $6,496 Mn + $97,207 Mn
- = $115,680 Mn
Total Debts in 2018
- Total debts in 2018 = $11,964 Mn + $8,784 Mn + $93,735 Mn
- = $114,483 Mn
By using the above-calculated values we will do the calculation of Debt to Asset for the Year 2017 and Year 2018.
Calculation of Debt to Asset Ratio in 2017
- Ratio in 2017 = Total debts in 2017 / Total assets in 2017
- = $115,680 Mn / $375,319 Mn
Ratio in 2017 will be –
- = 0.308
Ratio in 2018
- Ratio in 2018 = $114,483Mn / $365,725 Mn
Ratio in 2018 will be –
- = 0.313
Relevance and Uses
It is important to understand the debt to asset ratio because it is commonly used by creditors to measure debt quantity in a company. It can also be used to assess the debt repayment ability of a company to check if the company is eligible for any additional loans. On the other hand, the ratio is being used by the investors to ensure that the company is solvent, will be able to meet its current and future obligations and has the potential to generate a healthy return on their investment.
This ratio is typically used by investors, analysts and creditors to assess the overall risk of a company. A company with a higher ratio indicates that the company is more leveraged and hence it is considered to be a risky investment and the banker might reject the loan request of such entity. Further, if the ratio of a company increases steadily, it could be indicative of the fact that a default is imminent at some point in the future.
The following inferences can be used as a guide to assess the financial health of a company:
- If the ratio is equal to one, then it means that all the assets of the company are funded by debt which indicates high leverage.
- If the ratio is greater than one, then it means that the company has more debt in its books than assets. It is indicative of extremely high leverage.
- If the ratio is less than one, then it means that the company has more assets than debts and as such has the potential to meet its obligations by liquidating its assets if required.
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