The Debt to Asset Ratio - Its Importance and Calculation
Debt to asset ratio is the percentage of total assets that were paid for with borrowed money - creditors, liabilities, and debt. Some see it as an indicator of financial leverage; some interpret it as a measure of solvency, some see it as critical to financial health or financial distress. The ratio is expressed as a percentage.
If for instance, your company's debt to asset ratio is 56%, it means some form of debt has supplied about 56% of every dollar of your company's assets.
A high debt to assets ratio (over 1%) may mean that your company may 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.
The debt to asset ratio is 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 assets are financed using debt financing.
3 Steps to Calculating the Debt to Asset Ratio
Here are 3 steps to calculating the debt to asset ratio. All information comes from your company's balance sheet.
- To calculate the debt to asset ratio, you 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 your total debt is $100 and your total assets are $200, then your debt to assets ratio is 50%.
It means that 50% of your firm is financed by debt financing and 50% of your firm's assets are financed by your investors or by equity financing.
For this to mean anything to you, you need to compare this result with other years of data for your firm (trend analysis) and with the debt to assets ratio for other firms in your industry. If your debt ratio is too high, then you need to take a serious look at why.
Certainly, companies with a high debt to asset ratios may be at risk, especially in an increasing interest rate market. Creditors may get concerned if the company carries a large percentage of debt. They may demand that the company pay some of it back before extended more credit. The debt to equity ratio is often used instead of debt to asset. The liabilities to asset ratio, which is calculated as total liabilities divided by total assets, provides similar insight.