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What Is the Total Debt-to-Total Assets Ratio?
I'm going to explain the debt ratio, or total debt-to-total assets ratio, directly to you. You calculate it by dividing a company's total debt by its total assets. It's also known as the debt-to-assets ratio. This is a leverage ratio that shows how much debt a company has compared to the value of its assets.
You can use this metric to compare one company's leverage against others in the same industry. It gives you insight into the company's financial stability. If the ratio is higher, that means a higher degree of leverage, and depending on industry averages, it might mean higher risk when investing in that company compared to others.
Key Takeaways
You get the total debt-to-total assets ratio by dividing total debt by total assets. This shows you the extent to which a company uses debt to finance its assets. The calculation includes all debt, not just loans and bonds, and all assets, even intangibles.
For instance, if a company has a ratio of 0.4, that means 40% of its assets are financed by creditors, and 60% by owners' equity. Remember, this ratio doesn't tell you about the makeup of assets or how it stacks up against competitors in the industry.
Formula and Calculation
The formula for total debt-to-total assets is straightforward: it's total debt divided by total assets. Total debt covers both short-term and long-term liabilities. Here's how it looks: TD/TA = (Short-Term Debt + Long-Term Debt) / Total Assets.
You usually end up with a ratio less than 1.0, or 100%. This measures the portion of assets financed by debt rather than equity. If it's over 1, the company is technically insolvent because liabilities exceed assets. A 0.5 result means 50% financed by debt and 50% by equity.
What the Ratio Can Tell You
This ratio looks at a company's balance sheet, including all long-term and short-term debt, plus tangible and intangible assets. It shows you how much debt supports the assets and how those assets could service the debt. Essentially, it measures leverage.
You have to make debt payments no matter what, or the company risks breaching covenants and facing bankruptcy. Other liabilities might have some flexibility, but debt covenants don't. A high-leverage company might struggle more in a recession than one with low leverage.
Leverage Trends and Ability to Meet Debts
When you calculate this over years, you see trends in leverage use. For example, a drop of 0.1% each year for a decade shows the company is reducing leverage as it matures.
Investors check if the company can meet current debts and pay returns. Creditors look at existing debt to decide on new loans. If the ratio is over 1, not all debtors would get paid if operations stopped.
Example of Using the Ratio
Let's look at three companies: ABC with total debt of $107,633 million and assets of $359,268 million, giving a ratio of 0.30; DEF with $31,845 million debt and $63,852 million assets, ratio 0.50; XYZ with $18,239 million debt and $20,941 million assets, ratio 0.87.
ABC isn't burdened by debt and can likely get capital at lower rates. DEF is split evenly between debt and equity. XYZ has high debt, with nearly 90% of assets financed that way, giving it the least flexibility. You need to consider each company's size, industry, and goals—ABC is established, XYZ might rely more on loans.
Limitations of the Ratio
One issue is it doesn't indicate asset quality, mixing tangible and intangible together. For XYZ, if intangibles and goodwill make up a big part, the company might not cover debts even if the ratio suggests otherwise.
You should evaluate trends over time to see if risk is rising or falling. An increasing ratio might mean the company can't or won't pay down debt, pointing to future problems.
What Is a Good Ratio?
A good total debt-to-total assets ratio depends on the company's size, industry, sector, and strategy. Startups might have lower ratios, stable companies higher. Generally, 0.3 to 0.6 is comfortable for investors, but it varies.
Is a Low Ratio Good?
A low ratio isn't inherently good or bad. It means the company raises money via stock rather than loans, avoiding interest but sharing profits with shareholders.
How Do I Calculate It?
Divide total debts by total assets, including everything.
Can It Be Too High?
Yes, if it's above industry averages, like 50% in a 25% average industry, but many factors play in.
The Bottom Line
This ratio compares liabilities to assets to measure leverage, with higher ratios meaning more debt than equity. For the best view, compare over time or against similar companies in the industry.
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