The debt to total asset ratio indicates the percentage of total assets of the company financed from debt. It is a broad financial parameter for measuring what part of assets are served by liabilities (debt), signifying financial risk. And it is one of the solvency ratios and helps measure how far the company is capable of meeting its long-term financial obligations.
It is also known as the Debt Ratio.
Formula of Debt to Total Asset Ratio
The formula is as below:
|Debt to Total Asset Ratio = (Total Debt OR Total Liability) / Total Assets|
Total Debt = Long-Term Liabilities + Current Liabilities (i.e., Long-Term Debt and Short-Term Debt but does not include capital of shareholders)
Total Assets = All Assets (Current, Fixed, Tangible, Intangible)
Learn more about other types of Leverage Ratios
Analysis and Interpretation of Debt to Total Asset Ratio
Like other financial ratios, this ratio’s interpretation can be correct than its industry average or the value of this ratio with competitor companies. If this ratio is >0.5, it is considered that the company is highly leveraged, i.e., more than 50% of assets are from borrowings, either short term or long term.
A lower debt to total asset ratio is considered better as a sign of the company’s financial stability. This is because if the value of this ratio is low, it suggests that the company has borrowed fewer funds than its total assets. On the other hand, if the company has a high value of this ratio, it suggests that a company has borrowed huge funds and, therefore, higher financial risk.
A high debt to total asset ratio does not go too well with the investors. It suggests that creditors have claims on a high portion of the company’s assets. Also, if a company has high debt, it will end up paying a huge chunk of its operating profits on interest. This signifies a higher risk associated with the company’s operations.
Let’s look from a longer and futuristic perspective. A high debt to total asset ratio also suggests that the company is risky to invest in because it would not be able to secure loans for its future projects due to an already higher ratio resulting in lower borrowing capacity.
Visit How to Analyze and Improve Debt to Total Asset Ratio? for more details.
Calculate Debt to Total Asset Ratio with Example
Consider the following figures.
Current Liabilities = USD 50,000
Non-Current Liabilities = USD 250,000
Shareholder’s Equity = USD 100,000
Thus, we have,
Debt to Total Asset Ratio = 300000 / 400000 = 0.75
For Calculation, you can use our Total Debt to Total Assets Ratio Calculator.
Thus, it implied that about 75% of the company’s assets are met by debt. If a majority of this 75% of lenders start claiming their money, the company may face cash flow mismatch problems leading to bankruptcy.
Using Debt to Total Asset Ratio
It is important to compare the debt to total asset ratio of various companies within the same sector. The nature of some industries may require a company to borrow a lot of money. E.g., the Infrastructure sector. Thus, comparing this ratio of companies in different sectors might give you a misleading picture.
One can also use the debt to total asset ratio to gauge a company’s financials over a period of time. If the value of this ratio has increased significantly over a period of time, it may ring warning bells for the company and thereby for its investors.
Refer to Trend Analysis to learn more.