Debt Ratio

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Debt Ratio: Definition and Purpose

The debt ratio measures a company’s financial leverage by comparing its debt to its assets. It shows the portion of a company’s assets financed with borrowing and helps assess the risk that a firm may default on obligations if conditions worsen.

Key Takeaways

  • The debt ratio indicates how much of a company’s assets are financed by debt.
  • Capital-intensive industries (utilities, pipelines) typically have higher debt ratios than tech or service sectors.
  • The ratio is simple to compute from balance sheet figures but should be used with other metrics for a fuller risk assessment.

Formula and Example

Debt ratio = Total debt / Total assets

Example:
– Total assets = $100 million; Total debt = $30 million
– Debt ratio = 30 / 100 = 0.30 (30%)

Industry context matters: 30% may be low for a capital-intensive utility but high for a low-capital tech firm.

Pros and Cons

Pros
* Easy to calculate and understand.
* Uses readily available balance-sheet data.
* Offers a quick snapshot of financial leverage and solvency risk.
* Useful for trend analysis and peer comparisons within the same industry.

Cons
* Does not reveal the types, terms, or cost of debt.
* Relies on accounting figures that can vary by accounting method.
* Ignores profitability and cash-flow sufficiency.
* Not meaningful to compare across industries with different capital requirements.
* Reflects a single point in time and can change with transactions or asset revaluations.

Special Considerations

  • Terminology: Some sources use total liabilities (not just debt) as the numerator, creating ambiguity. Liabilities include obligations beyond debt (e.g., accounts payable).
  • Data scope: Financial data providers may count only short-term and long-term interest-bearing debt, excluding operating liabilities.
  • Consumer lending: Lenders use related ratios like gross debt service (housing costs ÷ income) and total debt service (housing plus other debt ÷ income) to evaluate borrowers.
  • Use the debt ratio together with profitability and cash-flow metrics to gauge true repayment capacity.

Debt Ratio vs. Long-Term Debt to Assets Ratio

  • Debt ratio includes all interest-bearing debt (short- and long-term) relative to total assets.
  • Long-term debt to assets considers only long-term obligations. Because it excludes short-term debt, it is usually lower than the overall debt ratio.

Examples

Starbucks (example)
– Total debt (short-term + long-term): ≈ $15.0 billion
– Total assets: ≈ $28.0 billion
– Debt ratio ≈ 15 / 28 = 0.536 → 53.6%
– Context: Retail/restaurant capital needs and industry norms affect whether this is considered high.

Meta (example)
– Total debt: ≈ $26.6 billion
– Total assets: ≈ $185.7 billion
– Debt ratio ≈ 26.6 / 185.7 = 0.143 → 14.3%

Common Related Ratios

  • Debt-to-equity ratio
  • Debt-to-assets (another name for debt ratio)
  • Long-term debt-to-assets
  • Leverage and gearing ratios

What Is a “Good” Debt Ratio?

There is no universal threshold. Generally:
* Debt-to-assets or debt-to-equity below 1.0 is often seen as safer.
* Ratios of 2.0 or higher are typically risky.
* Acceptable levels depend heavily on industry norms and the company’s cash-flow stability.

Can a Debt Ratio Be Negative?

Yes—if shareholder equity is negative (liabilities exceed assets), the debt ratio indicates extreme leverage and a heightened risk of insolvency.

Bottom Line

The debt ratio is a straightforward measure of leverage that helps investors and creditors judge a company’s financial risk. Interpreting it correctly requires industry context and complementary analysis of profitability, cash flow, debt terms, and accounting treatments.