Debt Ratio: Definition and Purpose The debt ratio measures a company's financial leverage by comparing its debt to its assets. It shows the portion of a company’s assets financed with borrowing and helps assess the risk that a firm may default on obligations if conditions worsen.
* Formula: Debt ratio = Total debt ÷ Total assets
* Interpretation:
* > 1.0 (or > 100%): liabilities exceed assets (negative equity). Explore More Resources
* < 1.0: assets exceed debt.
* Higher ratios imply greater leverage and financial risk; acceptable levels vary by industry.
Key Takeaways
* The debt ratio indicates how much of a company's assets are financed by debt.
* Capital-intensive industries (utilities, pipelines) typically have higher debt ratios than tech or service sectors.
* The ratio is simple to compute from balance sheet figures but should be used with other metrics for a fuller risk assessment.
Formula and Example Debt ratio = Total debt / Total assets Example:
- Total assets = $100 million; Total debt = $30 million
- Debt ratio = 30 / 100 = 0.30 (30%) Explore More Resources
Industry context matters: 30% may be low for a capital-intensive utility but high for a low-capital tech firm. Pros and Cons Pros
Easy to calculate and understand.
Uses readily available balance-sheet data.
Offers a quick snapshot of financial leverage and solvency risk.
Useful for trend analysis and peer comparisons within the same industry. Explore More Resources
Cons
Does not reveal the types, terms, or cost of debt.
Relies on accounting figures that can vary by accounting method.
Ignores profitability and cash-flow sufficiency.
Not meaningful to compare across industries with different capital requirements.
* Reflects a single point in time and can change with transactions or asset revaluations. Special Considerations
* Terminology: Some sources use total liabilities (not just debt) as the numerator, creating ambiguity. Liabilities include obligations beyond debt (e.g., accounts payable).
* Data scope: Financial data providers may count only short-term and long-term interest-bearing debt, excluding operating liabilities.
* Consumer lending: Lenders use related ratios like gross debt service (housing costs ÷ income) and total debt service (housing plus other debt ÷ income) to evaluate borrowers.
* Use the debt ratio together with profitability and cash-flow metrics to gauge true repayment capacity.
Debt Ratio vs. Long-Term Debt to Assets Ratio
* Debt ratio includes all interest-bearing debt (short- and long-term) relative to total assets.
* Long-term debt to assets considers only long-term obligations. Because it excludes short-term debt, it is usually lower than the overall debt ratio.
Examples Starbucks (example)
- Total debt (short-term + long-term): ≈ $15.0 billion
- Total assets: ≈ $28.0 billion
- Debt ratio ≈ 15 / 28 = 0.536 → 53.6%
- Context: Retail/restaurant capital needs and industry norms affect whether this is considered high. Explore More Resources
Meta (example)
- Total debt: ≈ $26.6 billion
- Total assets: ≈ $185.7 billion
- Debt ratio ≈ 26.6 / 185.7 = 0.143 → 14.3% Common Related Ratios
* Debt-to-equity ratio
* Debt-to-assets (another name for debt ratio)
* Long-term debt-to-assets
* Leverage and gearing ratios
What Is a “Good” Debt Ratio? There is no universal threshold. Generally:
Debt-to-assets or debt-to-equity below 1.0 is often seen as safer.
Ratios of 2.0 or higher are typically risky.
* Acceptable levels depend heavily on industry norms and the company’s cash-flow stability. Explore More Resources
Can a Debt Ratio Be Negative? Yes—if shareholder equity is negative (liabilities exceed assets), the debt ratio indicates extreme leverage and a heightened risk of insolvency. Bottom Line The debt ratio is a straightforward measure of leverage that helps investors and creditors judge a company’s financial risk. Interpreting it correctly requires industry context and complementary analysis of profitability, cash flow, debt terms, and accounting treatments. Explore More Resources