Looking to understand the financial health of a business before investing?
Understanding the debt ratio can give you the answers you need. It’s a key metric that reveals how much of a company’s assets are funded by debt versus equity—making it a must-know for business owners, investors, and financial pros.
In this article, we’ll break down what debt ratio is, why it matters, and how to calculate it so you can make smarter financial decisions, whether you're running a business, managing investments, or analyzing financial statements.
What is the debt ratio?
Debt ratio or debt to asset ratio is expressed as total debt divided by total assets. It measures a company’s or individual’s debt against its assets and helps determine the default risk of a company.
In other words, the debt ratio shows how much a company is leveraging or how much of its financing comes from loans and debts. Once we know this ratio, we can use it to determine how likely a company is to become unable to pay off its debts. Tools like Accounting software simplifies tracking the company finances, making it easier to calculate the debt ratio.
How to calculate debt ratio with formula?
To calculate the debt ratio of a company, you’ll need information about its debt and assets. This can be found on the company’s balance sheet. You can access the balance sheets of publicly traded companies on websites like Yahoo Finance, the U.S. Securities and Exchange Commission (SEC), Nasdaq, or the company's website.
From the balance sheet, determine total liabilities and assets first. Add up all a company's debts and obligations, including loans, accounts payable, and any other liabilities. Calculate the total value of everything the company owns, such as cash, inventory, property, equipment, and receivables.
Use the following formula to calculate the debt ratio.
Debt ratio = Total debt/Total assets
Suppose a company has:
- Total liabilities: $200,000
- Total assets: $500,000
The debt ratio is 200000/500000, which is 0.4 or 40%. This means 40% of the company’s assets are financed by debt.
Sometimes, accounts payable are included in total debt when calculating the debt ratio, but they are typically considered a short-term expense rather than part of a company’s outstanding debt. It’s up to you to decide whether or not to include them when calculating a company's debt ratio.
Example of debt ratio calculation and analysis
Let’s walk through an example of calculating debt ratio using data from Alphabet’s latest annual filing.
Total assets, as of December 2023: $402. 4 billion
Total liabilities, as of December 2023: $119 billion
Debt ratio = 119/402.4 = 0.3
At 0.3, Alphabet demonstrates that the company is not heavily reliant on borrowed funds, suggesting a strong financial position. This lower level of debt can be seen as a sign of financial stability and lower risk.
Alphabet is less vulnerable to interest rate changes and has more flexibility to invest in growth, innovation, or acquisitions without being overly burdened by debt obligations. This makes it more appealing to investors.
Free debt ratio calculator
Use our free debt ratio calculator below to quickly measure how much of the business assets are financed by debt. Just plug in the numbers, and let the calculator do the math for you!
What is a good debt ratio?
Generally, a lower debt ratio is better. The closer the ratio gets to 1, the more debt a company has in relation to its assets. If it is higher than 0.5, that means that more than half of a company’s working capital (the money it uses for operations and growth) is coming from debt. A rule of thumb for companies is to keep their debt ratios under 0.6, but a good debt ratio varies by industry.
Industries with steady cash flows usually have lower debt ratios, and industries with volatile cash flows have higher average debt ratios.
Investors, financial analysts, and shareholders must compare a company’s debt ratio to the average debt ratio in its industry or the debt ratios of its competitors if they want to effectively use the information to help them invest, trade, lend, or advise.
Use financial research software to easily compare debt ratios and other financial ratios across industries.
Difference between debt-to-equity ratio and debt-to-asset ratio
Now that you've calculated the debt ratio and know what a good debt ratio, it’s helpful to understand how it compares to other financial metrics. One of the most commonly used ratios alongside the debt ratio is the debt-to-equity ratio.
While both offer insights into a company’s leverage, they tell different stories about financial risk and funding sources.
The difference between a debt ratio and a debt-to-equity ratio is that when calculating the latter, you divide total liabilities by total shareholder equity.
- Debt-to-equity is more focused on how a company balances its debt with shareholder funds.
- Debt-to-asset looks at how much of the company’s assets are financed by debt. Both ratios are useful but serve different analytical purposes.
Investors often use the debt-to-equity ratio to evaluate the financial risk and return on equity, as higher leverage can increase potential returns but also increase risk. The debt-to-asset ratio, on the other hand, evaluated the company's ability to meet its long-term obligations, giving a broad view of its leverage.
It’s all fun and games...
...until somebody defaults on a loan. The debt ratio is a simple yet powerful tool to gauge a company’s financial health. By understanding how much of a business's assets are financed by debt, you can get a clear picture of its leverage and risk level. So, check your numbers, crunch those debts, and keep the financial foundation strong!
Want to crunch more numbers and assess a business's financial health? Learn about contribution margin with this free guide.
This article was originally published in 2019 and has been updated with new information.
