Debt Ratio Definition
Debt ratio, defined as an expression of the relationship between a company’s total debt and assets, is a measure of the ability to service the debt of a company. It indicates what proportion of a company’s financing asset is from debt, making it a good way to check a company’s long-term solvency. In general, a lower ratio is better. Value of 1 or less in debt ratios shows good financial health of a company.
Debt Ratio Meaning
Debt ratio, meaning a measure of the financial stability of a company, is a common evaluation for any investment which requires a loan. The lower the company’s reliance on debt for asset formation, the less risky the company is. On the other hand, the higher ratio means a company has high insolvent risk since excessive debt can lead to a heavy debt repayment burden.
Debt Ratio Formula
The debt ratio formula is used more simply than one would expect:
Debt ratio = total debt / total assets
Debt Ratio Calculation
A simple debt ratio calculation will put the simplicity of this equation into perspective.
Example: a company has $10,000 in total assets, and $8,000 in total debts. Debt ratio = 8,000 / 10,000 = 0.8
This means that a company has $0.8 in debt for every dollar of assets and is in a good financial health.
Debt Ratio Example
Riley is the average accountant. Showing up to the office from 9 – 5 every day Riley has earned her living through hours of study, analysis, and application. To Riley, the principals of accounting are useful for both professional and personal uses.
Riley is very good at equations such as debt ratio, mortgages and multinational corporations the same. Today, she wants to apply what she knows to her home financing. The debt ratio analysis she performs is listed below:
Riley has $10,000 in home equity and $100,000 in total debts.
Debt ratio = $100,000 / $10,000 = 10
This means that Riley has $10 in debt for every dollar of home equity.
Riley knows a web based debt ratio calculator will not serve the purpose that a skilled and certified analyst can. Riley is one of these people. She values her skills as she moves forward in her life.