Debt Ratio Explained: How to Calculate a Company’s Debt Ratio

In the world of corporate finance, a company's debt ratio is a side-by-side comparison of its debt obligations to its total assets.

• Debt: Corporate debt on a company's balance sheet can include items like a line of credit, capital borrowing that requires loan payments, mortgage payments on property, shareholder equity, and corporate credit card debt. Company owners should always separate their personal finances from their business finances, which means private debt like student loans, personal auto loans, personal credit card payments, and personal child support or alimony obligations should not factor into corporate debt.
• Assets: Corporate assets on a company's balance sheet can include cash on hand, accounts receivable balances, property and equipment, real estate holdings, inventory, and intellectual property. Just as an owner's personal loans or monthly debt payments should not factor into corporate debt, nor should personal assets count toward the company's assets.

A company's debt ratio can reveal information about its capital structure and offer a window into the company's financial leverage. The more leveraged a business is, the more it relies on its lenders for continued solvency. A company with high debt can suffer when interest rates rise, potentially forcing the company to channel its revenue toward loan repayments instead of paying salaries or buying new equipment. Some investors view higher debt ratios as a financial risk, which may dissuade them from buying into a company.

When a company's assets exceed its total amount of debt, the company enjoys more financial flexibility. A small business with lower debt can pay higher salaries and expand more aggressively since it does not need to spend a lot of money paying down debt. On the other hand, many business leaders subscribe to the notion of good debt. Loans provide immediate cash flow, and cash can be spent on expanding a business.

Calculating a total-debt-to-total-assets ratio requires finding two inputs: total debt and total assets.

1. 1. Calculate the total debt. A company's total debt reflects both short-term debt (which comes due within one year) and long-term debt (which will be repaid in more than one year's time). In corporate finance, total debt does not include liabilities. Short-term liabilities (like employee salaries, sales taxes, property taxes, and Social Security contributions) and long-term liabilities (like pension plans) are an inherent part of doing business but are not categorized as debt.
2. 2. Calculate the total assets. A business's total assets include both tangible assets (equipment, merchandise, cash-on-hand, total liabilities to be paid back by borrowers), and intangible assets (copyrights, patents, and goodwill).
3. 3. Input these numbers into the debt ratio formula. Once you have gathered these inputs, plug them into the debt-to-assets ratio formula: Debt-to-Asset Ratio = Total Debt / Total Assets.

When a business reports a debt-to-assets ratio that is greater than one, this means it has more debt than assets. If the ratio is less than one, the business has a higher total asset value than it does debt. Investors and loan providers are most likely to extend capital to a business with a debt ratio under 2.0. Anything higher would mean that the business has more than twice as much debt as assets.

It is important to always analyze debt ratios in the context of a particular industry. For instance, utility companies are known for taking on high levels of debt, so if a power company's debt-to-assets ratio shows a high degree of leverage, an investor would compare that financial ratio to the industry average. If its competitors have a similarly high ratio, the power company is probably doing fine, financially.

A debt ratio is only one way of measuring a company's financial health. Investment bankers and loan providers weigh it alongside other metrics such as a debt-to-income ratio, a debt-to-capital ratio, and a debt-to-equity ratio. Other lenders prefer a long-term debt-to-asset ratio, which only factors in long-term loans that are due in more than one year's time.

Some investors also like to review a company's complete financial portfolio—including its balance sheet and bank ledger—before choosing to invest capital. This re-emphasizes the concept that a debt ratio is important but far from the only metric that illustrates a company's finances.

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