A higher ratio indicates a larger portion of debt relative to assets, suggesting higher financial risk. Conversely, a lower ratio signifies a more conservative financial structure with less reliance on borrowed funds. The debt-to-asset ratio represents the percentage of total debt financing the firm uses as compared to the percentage of the firm’s total assets. It helps you see how much of your company assets were financed using debt financing. The total-debt-to-total-assets ratio compares the total amount of liabilities of a company to all of its assets. The ratio is used to measure how leveraged the company is, as higher ratios indicate more debt is used as opposed to equity capital.

  • Mr. Arora is an experienced private equity investment professional, with experience working across multiple markets.
  • The company can use this percentage to illustrate how it has grown and acquired its assets over time.
  • A ratio greater than one can prove to be a significant problem for businesses in cyclical industries where cashflows frequently fluctuate.
  • Another issue is the use of different accounting practices by different businesses in an industry.

We can see below that for the fiscal year (FY) ended 2017, Apple had total liabilities of $241 billion (rounded) and total shareholders’ equity of $134 billion, according to the company’s 10-K statement. For example, it is sometimes the case that a company can generate more profit in the medium term if it accepts reduced revenues in the short term. You see this for instance in cases where a company needs to divest itself from an unprofitable subsidiary or revenue stream. If the company has a high debt burden, however, it may be unable to make such decisions because its interest and principal payments make it unable to tolerate even a short-term decline in revenue. For companies with low debt to asset ratios, such as 0% to 30%, the main advantage is that they would incur less interest expense and also have greater strategic flexibility.

Industry Variations

The debt to assets ratio does not take into account the market value of assets, as it relies on historical cost accounting. Therefore, it may not accurately reflect the actual value of a company’s assets or its ability to generate future cash flows. Different industries have varying levels of acceptable debt to assets ratios. For instance, capital-intensive industries like manufacturing or infrastructure tend to have higher ratios due to the need for substantial investments in assets.

  • If some of the firms use one inventory accounting method or one depreciation method and other firms use other methods, then any comparison will not be valid.
  • As with all financial metrics, a “good ratio” is dependent upon many factors, including the nature of the industry, the company’s lifecycle stage, and management preference (among others).
  • This ratio determines a company’s level of indebtedness, in other words, the proportion of its assets that is owned by its creditors.
  • A ratio of greater than one means that a company owes more in debt than they possess in assets.

In order to perform industry analysis, you look at the debt-to-asset ratio for other firms in your industry. Furthermore, the interpretation of the Total Asset Ratio should consider industry-specific characteristics, as different industries have varying capital requirements and financing practices. It is also important to consider the company’s business model, growth strategy, and overall financial objectives when evaluating the Total Asset Ratio.

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“Total liabilities really include everything the company will have to repay,” she adds. A company with a high D/A ratio will eventually take a penalty on its value, as the risk of default is higher than that of a company with 0 leverage. For example, a company might determine that ceasing to offer a particular product or service would be in their best long-term interest. The company can use this percentage to illustrate how it has grown and acquired its assets over time. On the other hand, investors use it to ensure that the company remains solvent and can meet current and future obligations. A company with a lower proportion of debt as a funding source is said to have low leverage.

How to Calculate the Debt to Assets Ratio

The debt to assets ratio provides a snapshot of a company’s overall financial health. It offers insights into its capital structure and indicates the extent to which the company relies on borrowed funds. A healthy ratio demonstrates a balanced mix of debt and equity, which enhances confidence among investors and lenders. Interpreting the debt to assets ratio involves understanding the proportion of a company’s assets that are financed by debt.

Debt to Assets Ratio

Bear in mind how certain industries may necessitate higher debt ratios due to the initial investment needed. The debt ratio aids in determining a company’s capacity to service its long-term debt commitments. As discussed earlier, a lower debt ratio signifies that the business is more financially solid and lowers the chance of insolvency. With this information, investors can leverage historical data to make more informed investment decisions on where they think the company’s financial health may go.

It is a measure of the degree to which a company is financing its operations with debt rather than its own resources. Let’s assume that a corporation has $100 million in total assets, $40 million in total liabilities, and $60 million in stockholders’ equity. This corporation’s definition explanation and examples is 0.4 ($40 million of liabilities divided by $100 million of assets), 0.4 to 1, or 40%. This indicates 40% of the corporation’s assets are being financed by the creditors, and the owners are providing 60% of the assets’ cost.

The Debt to Asset Ratio Formula

First, it illustrates the percentage of debt used to carry a company’s assets and how these assets can be used to service loans. A ratio that is greater than 1 or a debt-to-total-assets ratio of more than 100% means that the company’s liabilities are greater than its assets. A ratio that is less than 1 or a debt-to-total-assets ratio of less than 100% means that the company has greater assets than liabilities.