Debt ratio is a ratio that indicates the proportion of a company's debt to its total assets. It shows how much the company relies on debt to finance assets. The debt ratio gives users a quick measure of the amount of debt that the company has on its balance sheets compared to its assets. The higher the ratio, the greater the risk associated with the firm's operation. A low debt ratio indicates conservative financing with an opportunity to borrow in the future at no significant risk.
Debt ratio is similar to debt-to-equity ratio which shows the same proportion but in different way.
The debt ratio is calculated by dividing total liabilities (i.e. long-term and short-term liabilities) by total assets:
Debt ratio = Liabilities / Assets
Both variables are shown on the balance sheet (statement of financial position).
Norms and Limits
The optimal debt ratio is determined by the same proportion of liabilities and equity as a debt-to-equity ratio. If the ratio is less than 0.5, most of the company's assets are financed through equity. If the ratio is greater than 0.5, most of the company's assets are financed through debt.
Maximum normal value is 0.6-0.7. But it is necessary to take into account industry specific, explained in the article about debt-to-equity ratio.
Exact Formula in the ReadyRatios Analytic Software
Debt ratio = F1[Liabilities] / F1[Assets]
F1 – Statement of financial position (IFRS).
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