Debt ratio is a measure of a company's debt as a percentage of its total assets. It shows how much the company relies on debt to finance its assets. The debt ratio gives users a quick measure of the amount of debt the company has on its balance sheet compared to its assets. The higher the ratio, the greater the risk associated with the company's operations. A low debt ratio indicates conservative financing with the ability to borrow in the future without significant risk.
The Debt Ratio is similar to the Debt-to-Equity Ratio, which shows the same ratio but in a different way.
Debt ratio Formula
The debt ratio is calculated by dividing total liabilities (i.e. long-term and short-term liabilities) by total assets:
Both the numerator and denominator in this calculation are always positive numbers, so the resulting ratio cannot be negative. It's theoretically possible for a company's debt ratio to be zero, meaning that the company has no debt and only equity or assets. But in practice, it's almost impossible.
Both variables are reported on the balance sheet (statement of financial position).
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 ReadyRatios Analysis Software
Debt ratio = F1[Liabilities] / F1[Assets]
there F1 – Statement of financial position (IFRS).
There is our industry benchmarking calculated using US SEC data, where you can find average values for debt ratios.
The debt ratio for public companies and small companies can differ depending on various factors such as the industry they operate in, their size, and their management's financial strategy.
Large public companies, especially those that have been in operation for a long time and have a strong track record of profitability, tend to have lower debt ratios as they have access to a wide range of funding options such as equity, bonds, and bank loans. They also have more resources available to them to pay off their debt, such as cash flow from operations and the ability to raise additional capital through equity offerings.
Smaller companies, especially those that are new or are in a capital-intensive industry, may have higher debt ratios as they may not have the same level of profitability, cash flow, or access to capital as larger companies. They may have to rely more heavily on debt financing to fund their operations and growth.
You should note that there are no specific rules or regulations that dictate what a "good" or "bad" debt ratio is for public companies or small companies, as it varies based on the industry, the company's risk profile and the company's overall financial health. Some industries may have higher ratios of debt to equity than others, and some companies may have a higher tolerance for debt than others. A debt ratio does not necessarily indicate whether a company is financially healthy or not, it just one of the indicators used to assess a company's financial leverage. Other financial ratios and financial statements should be considered when evaluating a company's overall financial health and performance.