Finance
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Boundless Finance
Analyzing Financial Statements
Debt Management Ratios
Finance Textbooks Boundless Finance Analyzing Financial Statements Debt Management Ratios
Finance Textbooks Boundless Finance Analyzing Financial Statements
Finance Textbooks Boundless Finance
Finance Textbooks
Finance
Concept Version 8
Created by Boundless

Total Debt to Total Assets

The debt ratio is expressed as Total debt / Total assets.

Learning Objective

  • Use a company's debt ratio to evaluate its financial strength


Key Points

    • The debt ratio measures the firm's ability to repay long-term debt by indicating the percentage of a company's assets that are provided via debt.
    • Debt ratio = Total debt / Total assets.
    • The higher the ratio, the greater risk will be associated with the firm's operation.

Terms

  • goodwill

    Goodwill is an accounting concept meaning the value of an asset owned that is intangible but has a quantifiable "prudent value" in a business for example a reputation the firm enjoyed with its clients.

  • debt to total assets ratio

    after tax income divided by liabilities


Example

    • For example, a company with 2 million in total assets and 500,000 in total liabilities would have a debt ratio of 25%.

Full Text

Financial Ratios

Financial ratios quantify many aspects of a business and are an integral part of the financial statement analysis. Financial ratios are categorized according to the financial aspect of the business which the ratio measures.

Financial ratios allow for comparisons:

  • Between companies
  • Between industries
  • Between different time periods for one company
  • Between a single company and its industry average

Ratios generally are not useful unless they are benchmarked against something else, like past performance or another company. Thus, the ratios of firms in different industries, which face different risks, capital requirements, and competition, are usually hard to compare.

Debt ratios

Debt

Debt ratio is an index of a business operation.

Debt ratios measure the firm's ability to repay long-term debt. It is a financial ratio that indicates the percentage of a company's assets that are provided via debt. It is the ratio of total debt (the sum of current liabilities and long-term liabilities) and total assets (the sum of current assets, fixed assets, and other assets such as 'goodwill').

  • Debt ratio = Total debt / Total assets

Or alternatively:

  • Debt ratio = Total liability / Total assets

The higher the ratio, the greater risk will be associated with the firm's operation. In addition, high debt to assets ratio may indicate low borrowing capacity of a firm, which in turn will lower the firm's financial flexibility. Like all financial ratios, a company's debt ratio should be compared with their industry average or other competing firms.

Total liabilities divided by total assets. The debt/asset ratio shows the proportion of a company's assets which are financed through debt. 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. Companies with high debt/asset ratios are said to be "highly leveraged," not highly liquid as stated above. A company with a high debt ratio (highly leveraged) could be in danger if creditors start to demand repayment of debt.

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