Debt Ratio

Definition

The debt ratio is a simple indicator of the leverage used by a company.  The debt ratio measures the proportion of the total assets that are financed by debt, and not by stockholders.

Calculation

Debt Ratio = Total Liabilities / Total Assets

Explanation

The debt ratio requires only two inputs in its calculation, both of which can be obtained from a company's balance sheet.  By dividing liabilities by assets, this ratio tells the analyst how much debt was used to finance the assets of the company.

A relatively high debt ratio will produce good results for stockholders as long as the company earns a rate of return on assets that is greater than the interest rate paid to creditors.  As the ratio increases, there is a greater risk that creditors could force the company into bankruptcy if it falls behind on interest payments.

Generally, it's desirable to have a debt ratio that is less than 0.5.  When a company's ratio rises above 0.5, it is said to be highly leveraged.  When drawing conclusions about the relative performance of a company, benchmark comparisons should be made with competitors in the same industry.

Example

Company A's balance sheet indicates total assets of $31,616,000 and total liabilities of $16,196,000.  Using the above formula, the debt ratio would be:

= $16,196,000 / $31,616,000, or 0.51

Related Terms

balance sheet, assets, liabilities, leverage, leverage ratio, equity ratio