The debt to asset ratio is a correspondence between the total debt and the total assets of a company. It shows what percentage of the resources is funded by debt rather than equity.
A high debt to asset ratio implies a high financial risk. But it implies a higher equity return in case of a strong economy.
This scale is used commonly by stakeholders and creditors. The former group uses it to determine two factors: whether the given company has sufficient funds to pay its debts, and whether it can pay the return on the group’s investment.
The latter group (the creditors) determines the possibilities of giving supplementary loans to the enterprise. If the debt to asset ratio is remarkably high, it reveals that repaying preexisting debts is already improbable and additional loans are a risky investment.
To compute the debt to asset ratio, you have to read two factors from your company's balance sheet:
Given below is the debt to asset ratio formula:
Debt to asset ratio = (short term debt + long term debt) / total resources (Assets) * 100%
This scale is typically represented as a percentage. However, you might come across a value like 0.56 or 1.22. To obtain a result in percentages, just multiply this type of value by 100%.
Consider that you're a banker. Two enterprises approach you for a long term loan. You can read and analyze the information from their balance sheets that have been given below.
Company A:
Company B:
Employing the debt to asset ratio formula for both of the companies, we arrive at the following result:
Company A: \((\dfrac{300.50}{850.20}) * 100% = 35%\)
Company B: \((\dfrac{(240.60}{200.68)} * 100% = 120%\)
Now as you can see above, the values for the debt to asset ratio are completely different. What do these results imply? The proportion for company A is somewhat low - it implies that most of the company's assets are financed by equity.
Armed with this information, we can conclude that company A is in a decently good financial shape. Company B, however, is rather in a far riskier state, as their liabilities exceed their assets/resources. For a bank, it is logical to give loan to company A only.
The above example displays that the relation between the debt to asset ratio and the company's financial condition is simple: the higher the percentage, the riskier its financial health.
If the company’s debt to asset ratio exceeds 100%, it means that a company has more liabilities (usually in the form of debt) than assets/resources and may even declare bankruptcy soon.
However, going all through this manually could be a tough nut to crack and we’re not even talking Human Error yet. So it is better to
However, there are definitely upsides to a higher debt to asset ratio. It shows a sharp degree of flexibility, which resultantly means higher returns in the case of success (provided that someone is willing to invest in your high-risk company).
Undeniably, however, debt to asset ratio is not the only gauge of a company's debt/liabilities management. To get the bigger picture for B, you should also take note of the other metrics like their debt services coverage ratio.
However, going through all these calculations manually can be a tough nut to crack and we’re not even talking Human Error yet. Thus, Soft has developed this Debt to Assets Ratio Calculator.
It calculates the debt to assets ratio based on the total debt ratio formula and delivers results in real-time. On top of that, it is free to use tool no matter how many times you use it. The cherry on top is you don’t have to register to the site either.
Our tool is extremely useful for bankers, other financial institutions and corporate companies. Analysts and Investors use this calculator to determine the risk of investing in a company.
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