Debt to Asset Ratio Definition

When analyzing your default risk on debt such as credit and loans, the debt to asset ratio can help show the financial health of your business.

In addition, you can use the debt to asset ratio to compare previous ratios as well as business financial growth over time. When calculating your debt-to-asset ratio and interpreting the results, it’s important to know all the financial information you need to use to determine the ratio.

In this article, you’ll learn how to calculate your debt-to-asset ratio and what those results mean for your business.

Contents

1 What is Debt to Asset Ratio?
2 How to Calculate Debt to Asset Ratio?
2.1 1. Calculate total liabilities
2.2 2. Calculate total assets
2.3 3. Place both quantities in the appropriate places in the formula
2.4 4. Calculate the debt-to-asset ratio using the formula
3 Interpreting Debt to Asset Ratio
4 Case Examples in Calculating Debt to Asset Ratio

What is the Debt to Asset Ratio?

Debt to asset ratio or the ratio of debt to assets, or the ratio of total debt to total assets, is an indication of the company’s financial leverage.

The debt to assets ratio of a company measures its assets which are financed by its liabilities (debt) rather than its equity. This ratio can be used to measure the company’s growth through the assets it acquires from time to time.

Investors can use the debt-to-asset ratio to evaluate whether a business has sufficient funds to meet its debt obligations, as well as to assess whether an organization can pay a return on investment.

In addition, the debt-to-asset ratio can be used as an indicator to measure the company’s financial leverage. It shows the percentage of total business assets financed by creditors. The formula for calculating the debt-to-asset ratio looks like this:

Debt-to-Assets Ratio = Total Debt / Total Assets.

The total amount of debt, or current liabilities, divided by the total amount the company has in assets, whether short-term or long-term investments and capital assets.

To calculate total liabilities, both short-term and long-term debt are added up to get the total amount of liabilities the company has to pay.

How to Calculate Debt to Asset Ratio?

To calculate the debt-to-asset ratio, you must first analyze your business balance sheet. It can also help to calculate the debt-to-asset ratio for as long as the business has been in operation, providing a complete picture of a company’s financial growth or decay.

The following steps show you how to apply the debt-to-asset formula to calculate the ratio:

1. Calculate total liabilities

Your first step in calculating your debt-to-asset ratio is to calculate all of your business’ current liabilities. You may have short-term loans, long-term debt or other obligations that arise from time to time.

Once you get this number, it can fit into the formula. For example, a company might account for all small business loans it has received and repaid, as well as any funding from creditors the business has received during its operations.

2. Calculate total assets

After calculating all current liabilities, you can then calculate the total amount of assets the business has. These assets can include quick assets (such as cash and cash equivalents), long-term investments, and any other investments that have generated income for your business. Once you have this amount, place it in the appropriate area according to the debt-to-asset ratio formula.

3. Place both quantities in the appropriate places in the formula

Once these two amounts are calculated, plug each element into the debt-to-asset ratio formula. The total liabilities will be dividends, while the total assets act as the divisor.

4. Calculate the debt-to-asset ratio using the formula

Now that your amount is placed in the appropriate place in the formula, you can go ahead and calculate your debt-to-asset ratio. Divide total liabilities by total assets, and the result will appear as a decimal.

It can also be converted to a percentage, which indicates the percentage of liabilities financed by creditors, investors, or other similar entities.

Interpreting Debt to Asset Ratio

Once you have calculated the debt-to-asset ratio, you can then analyze the results. Usually, a debt-to-asset ratio greater than one, such as 1.2, can indicate that a company’s liabilities are higher than its assets.

In addition, a debt-to-asset ratio that is greater than one can also indicate that most of a business’s debt is funded by its assets. A higher ratio usually indicates that a business may be at risk of default on a loan, especially if interest rates increase.

A debt-to-asset ratio of less than one, for example, 0.64, can indicate that most of your business assets are funded by equity, and that the risk of default or even bankruptcy is low. Furthermore, the decimal 0.64 can be converted to a percentage, indicating that 64% of your business liabilities are covered by your assets.

Case Example in Calculating Debt to Asset Ratio

It can sometimes be helpful to see examples that illustrate how this formula works, as well as the interpretation of the debt-to-asset ratio resulting from your calculations.

In the following example, we calculate the debt-to-asset ratio and then use the resulting figures to analyze the risk of a company defaulting on a loan or the risk the company may have in filing for bankruptcy.

For example, let’s say the CEO of a mid-sized company wants to calculate the company’s debt-to-asset ratio. A financial advisor may assist in this process, and they will first analyze the company’s balance sheet to determine the total amount of liabilities as well as the total amount of assets.

Total liabilities of the company = $38,000
Total assets of the company = $100,000
Total shareholder equity = $62,000

The financial advisor then uses the debt-to-asset ratio formula to calculate the percentage:

(Total liabilities) / (total assets) = ($38,000) / ($100,000) = 0.38:1 or 38%

This ratio shows that the company’s assets are financed by creditors or loans, while 62% of the company’s asset costs are provided by the business owner.

This ratio further indicates that the company has a low default risk, which can be beneficial if the organization seeks further credit for renovations, expansions, product inventory increases or other expenses the company may need to take care of in the future.

In addition to the calculation of the current debt-to-asset ratio, companies may choose to compare the results with the previous debt-to-asset ratio at an earlier date and over time, the targeted ratio and the competitor’s debt-to-asset ratio to help indicate what steps the business may need to take to further reduce the risk.