Of the many financial analysis terms used, debt ratio is a prominent one. In this article, you will find a clear definition of this ratio and a calculator tool, which provides you with the functionality to compute it instantly.
The accounting scalpel dissects the financial balance sheets of a company, with the purpose of determining the exact fiscal health of the business. There are many tools and concepts which make it easier to determine the fiscal health and leverage used by a company. One such concept is the debt ratio.
It is the ratio of the total external debt of any business to its overall assets. This ratio is often expressed in terms of a percentage. It is the direct proportion of the total debt burden of any company to its total fixed, as well as monetary assets. It is calculated to determine the leverage that a business has, on the basis of external credit it has opted for. It also determines the degree of financial risk a company has taken to fund its operations. When you consider investing into the stocks of any public listed company, one of the first things you need to investigate is the amount of debt burden, which the company has taken upon itself.
A calculation of the debt ratio can give you an idea about how dependent the company is on external borrowing. A high value indicates that the company is majorly dependent on external investment and already possesses a heavy financial burden. Such a business finds it difficult to avail new credit lines due to previous debt. A low debt-to-asset ratio indicates that the company is sufficiently financially independent and is obviously a better option for investment. For example, the current ratio of Microsoft Corporation is 46.4%, while that of Google Inc. is 20.1%. This type is known as a solvency ratio and along with the long term debt-to-equity ratio, plays an important role in determining the fiscal health of any company.
Debt Ratio = Total Debt/Total Assets
So to calculate the value, you need to know the total external debt of the company, along with the valuation of its assets. The total external debt may include its tax liabilities and accounts payable, along with other operational costs involved in running the business.
The assets used to calculate the ratio will include the valuation of current fixed assets, according to market value, plus other liquid assets of the company. To make it easy for you to calculate the ratio in percentage, I provide a calculator tool below.
Here are a few guidelines on using the calculator. Enter the numerical value in USD, of the ‘Total Debt’ and ‘Total Assets’ of a business in the form fields below and then click on the calculate button to get the value in percentage. (Don’t enter values with commas). To calculate the value again, hit the ‘Reset’ button and re-enter values.
To conclude, let us review some of the important points to remember. A low value of the debt-to-asset ratio indicates robust fiscal health. On the other hand, a high value indicates increasing dependency of the company over external investment and a higher investment risk. A low ratio value is a sign of sound financial condition of the company. Use the calculator tool provided above to determine the value of the ratio from the knowledge of the monetary value of assets and total debt of the business.