The Debt to Asset Ratio - Its Importance and Calculation
A company's debt to asset ratio shows the percentage of total assets that were paid for with borrowed money, represented by debt on the balance sheet. Some see it as an indicator of financial leverage or a measure of solvency, while others see it as a critical insight into a firm's financial health or distress. The ratio is expressed as a percentage.
If for instance, your company has a debt to asset ratio of 56 percent, it means some form of debt has supplied about 56 percent of every dollar of your company's assets.
A high debt to assets ratio of over 1 percent could mean that your company will have trouble borrowing more money, or may borrow money at a higher interest rate than if the ratio were lower. Highly leveraged companies may be putting themselves at risk of insolvency or bankruptcy, depending upon the type of company and industry.
The debt to asset ratio represents the percentage of total debt financing the firm uses as compared to the percentage of the firm's total assets. It helps you see how much of your company assets were financed using debt financing.
Calculating the Debt to Asset Ratio
Take the following three steps to calculate the debt to asset ratio. All information comes from your company's balance sheet.
- To calculate the debt to asset ratio, look at the firm's balance sheet; specifically, the liability side of the balance sheet. Add together the current liabilities and the long-term debt.
- Look at the asset side of the balance sheet. Add together the current assets and the net fixed assets.
- Divide the result from Step 1 (total liabilities or debt) by the result from Step 2 (total assets). You will get a percentage. For example, if you have total debt of $100 and your total assets are $200, then you have a debt to assets ratio of 50 percent.
It means that 50 percent of your firm is financed by debt financing and 50 percent of your firm's assets are financed by your investors or by equity financing.
To find relevant meaning in the ratio result, compare it with other years of ratio data for your firm using trend analysis, and with the debt to assets ratio for other firms in your industry. If your debt ratio is too high relative to your company's own history or the industry-standard ratio, it's important to take an investigative look at the driving causes.
Companies with a high debt to asset ratio may be at risk, especially in an increasing interest rate market. Creditors might get concerned if the company carries a large percentage of debt. They may demand that the company pay some of it back before taking on any more debt.
The debt to equity ratio is often used instead of the debt to asset ratio. The liabilities to asset ratio, calculated as total liabilities divided by total assets, provides similar insight.