May 8, 2024

Debt-To-Total-Assets Ratio Definition, Calculation, Example

Creditors use the ratio to see how much debt the company already has and whether the company can repay its existing debts. The debt-to-equity ratio tells you how much debt a company relies on rather than its own funds. A high ratio will tell you a company uses a lot of debt to finance its operations and growth, which can be risky if profits drop or if interest rates increase. A low ratio will tell you a company is not using a lot of debt, relying on its earnings to facilitate business.

Improve Debt Management Practices

This ratio explains the portion of the capital structure of a business that has been funded by debt. It is used to calculate the risk level or leverage if the company and also shows the obligations like interest payments on bonds or loans. Debt to total assets analysis helps you see if your business has a healthy amount of debt and allows you to gauge the risk of defaulting on payments. The debt to total assets ratio is limited in scope, providing a snapshot of a single moment in time and focusing only on debt relative to assets. For example, a company with a high proportion of intangible assets, such as patents, may carry a different risk profile than one with extensive tangible assets like machinery.

Explore the debt to assets ratio, its calculation, components, and its role in credit analysis across different sectors.
A lower debt ratio often signifies robust equity, indicating resilience to economic challenges.
Next, take a look at your balance sheet again to see your business’s total debt figure, which should include both short-term and long-term debt obligations.
In other words, it shows what percentage of assets is funded by borrowing compared with the percentage of resources that are funded by the investors.
A ratio approaching 1 (or 100%) indicates that nearly all of the company’s assets are financed by debt.
For example, start-up tech companies are often more reliant on private investors and will have lower total debt-to-total-asset calculations.
With this information, investors can leverage historical data to make more informed investment decisions on where they think the company’s financial health may go.

Inventory and Asset Management

Such comparisons enable stakeholders to make informed decisions about investment or credit opportunities.
But your DTI is only one of the many factors lenders review when considering whether to approve you for a loan.
They must be assessed in relation to other metrics, in relation to other periods, and in relation to other businesses, industry averages, and expectations.
On the other hand, it will have less fund to meet its day to day operations, hindering its growth and expansion.
It tells you the percentage of a company’s total assets that were financed by creditors.
A high ratio indicates that a company may be at risk of default on its loans if interest rates suddenly rise.
If there is a significant increase in total liabilities, then this will affect the debt-to-total asset ratio positively.

This assessment can what is cost accounting be particularly vital for creditors, investors, and other stakeholders when evaluating the financial health of an organization. In contrast, companies looking to expand or diversify might again increase borrowing, potentially raising the ratio. Understanding where a company is in its lifecycle helps contextualize its debt ratio.

Can a Debt Ratio Be Negative?

Companies can generate investor interest to obtain capital, produce profits to acquire its own assets, or take on debt. Yes, a very low ratio might indicate that a company is under-leveraged cash basis accounting: explain examples, contrast with accrual and not making the most of potential growth opportunities by using available financing options. A low debt-to-asset ratio may seem like a sign of financial strength, but it could also indicate that a company is not leveraging debt effectively for growth and expansion. On the other hand, an extremely low ratio (0% to 30%) may suggest underutilization of financial leverage, potentially leading to missed growth opportunities or suboptimal returns for shareholders. For instance, you can gauge your business’s operational efficiency with activity ratios , which can tell you how efficiently it utilises assets and resources. The ratio also doesn’t tell you anything about your business’s cash flow, productivity, efficiency or profitability.

XYZ may find investor demands are too great to secure financing, turning to financial institutions for capital instead. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

Long-Term Debt Ratio

As a result, drawing conclusions purely based on historical debt ratios without taking into account future predictions may mislead analysts. If its assets provide large earnings, a highly leveraged corporation may have a low debt ratio, making it less hazardous. Contrarily, if the company’s assets yield low returns, a low debt ratio does not automatically translate into profitability. The periods and interest rates of various debts may differ, which can have a substantial effect on a company’s financial stability. In addition, the debt ratio depends on accounting information which may construe or manipulate account balances as required for external reports.

Examples of DTI requirements

Debt ratio is a metric that measures a company’s total debt, as a percentage of its total assets. A high debt ratio indicates that a company is highly leveraged, and may have borrowed more money than it can easily pay back. Investors and accountants use debt ratios to assess the risk that a company is likely to default on its obligations. In credit analysis, the debt to assets ratio is a critical measure of financial stability and risk management. It reflects a company’s leverage and its ability to service debt over the long term. A lower ratio often signals a conservative financial approach, which can indicate resilience during economic downturns.

Let us take the example of Apple Inc. and calculate the debt to asset ratio in 2017 and 2018 based on the following information. Therefore, we can say that 41.67% of the total assets of ABC Ltd are being funded by debt. On the other hand, a food services business would have a lower acceptable ratio given its need to purchase tangible assets is not as significant. If you have a ratio over 1, this could be a warning of financial difficulties ahead as your business’s debt is greater than its assets. A ratio of one indicates that your business has a high level of debt, and theoretically, if you needed to pay it off all at once, you would need to sell all your assets.

Analyze Investments Quickly With Ratios

Ratios higher than 2 are generally unfavorable, although industry and similar company averages have to be considered in the evaluation. The D/E ratio can also indicate how generally successful a company is at attracting equity investors. The industries that typically have the highest D/E ratios include utilities and financial services. That means a mortgage lender is more likely to approve her for a loan, especially with good credit and a stable job history.

A higher ratio might prompt a reevaluation of the company’s borrowing strategy, while a lower ratio might suggest that more debt could be used to fund growth or expansion. The ratio allows for meaningful comparisons between companies in the same industry. Different industries have varying capital structures, and the ratio serves as managing an audit a tool to assess relative financial health.