What Is the Debt Ratio?

Define Debt Ratio in Simple Terms

The debt ratio is the ratio of a company’s debts to its assets, arrived at by dividing the sum of all its liabilities by the sum of all its assets.

It is a measurement of how much of a company’s assets are financed by debt; in other words, its financial leverage.

If the ratio is above 1, it shows that a company has more debts than assets, and may be at a greater risk of default.

Debt Ratio Formula

To find a business‘ debt ratio, divide the total debts of the business by the total assets of the business.

Check out the debt ratio equation:

What Does Debt Ratio Mean in Finance?

The purpose of calculating the debt ratio of a company is to give investors an idea of the company’s financial situation.

Too high a debt ratio can indicate a looming problem for a company. At the very least, a company with a high amount of debt may have difficulty paying or maintaining dividend payments for investors.

Likewise, too low of a debt ratio could mean that the company in question is underinvesting in assets and stunting their own growth, which could mean that equity shares will be slow to appreciate in value, if at all.

Debt Ratio Example

Debt ratios can vary widely depending on the industry of the company in question.

For example, capital intensive businesses, such as those in the energy sector, generally take on more debt than companies in the IT sector.

Because of this, what is considered to be an acceptable debt ratio by investors may depend on the industry of the company in which they are investing.

In order to get a more complete picture, investors also look at other metrics, such as return on investment (ROI) and earnings per share (EPS) to determine the worthiness of an investment.

Debt Ratio Definition FAQs

It is a measurement of how much of a company’s assets are financed by debt; in other words, its financial leverage.
To find a business’s debt ratio, divide the total debts of the business by the total assets of the business.
The purpose of calculating the debt ratio of a company is to give investors an idea of the company’s financial situation.
Too high a debt ratio can indicate a looming problem for a company. At the very least, a company with a high amount of debt may have difficulty paying or maintaining dividend payments for investors.
What is considered to be an acceptable debt ratio by investors may depend on the industry of the company in which they are investing. For a more complete picture, investors also look at metrics such as return on investment (ROI) and earnings per share (EPS) to determine the worthiness of an investment.

About the AuthorTrue Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.