Finance

Know Your Debt to Asset Ratio, and You’ll Know Your Financial Risk

Know Your Debt to Asset Ratio, and You’ll Know Your Financial Risk

Let’s get straight into things.

A debt to asset ratio is a very handy business feature that is sometimes referred to as simply ‘debt ratio’ is a very handy figure (known as a ‘leverage ratio’) that allows you to see the percentage of your assets that are financed and funded by debt, aka, the money you own. It’s another way of seeing how much of your business your actually own and how much is debt.

If you started a company and you took a loan out for $100,000 and used $25,000 of your own money, you would own 20% of your business, but your debt ratio would be 80%. This is an incredibly handy figure when you’re investing because you can look into a business and see exactly how much of a financial risk it’s going to be if you were to invest.

Creditors will use this ratio all the time to figure out how much debt a company is in before offering more credit, as well as assessing how capable of repaying the debt the company is, and whether or not it would be a good idea to offer more loans and at what interest rates.

Likewise, investors, as we said above, will also use this ratio to figure out whether a company they invest in will provide a return.

How to Work Out Your Debt to Asset Ratio

While it may sound like a lot of financial lingo, working out your own ratio (or the ratio for any company, for that matter) isn’t too difficult. You just need to follow the formula below:

Short-term debt plus long-term debt divided by the value of total assets.

In short-hand, this will look something like:

Short term debt + long-term debt / total assets = debt/asset ratio

Just for clarity, total assets will refer to any and all assets the business has, and that is recorded on the balance sheet of the company. Both short and long-term debt combined is also referred to as ‘liabilities.’ It can also include assets like property, equipment, and so on, but it completely depends on the person who is carrying out the formula and what they want to know.

As an example, take a look at the balance sheet below, and see if you can work out what the debt to asset ratio is.

Assets$$
Cash230,567
Accounts7,800
Inventory9,200
Property85,000
Equipment2,000
Debt
Accounts6,778
Debt80,000

First, you add together all the assets, which would total $334,567, and all the debt, which would total $86,778. Using the formula above, you can then work out that the debt to asset ratio (figured out by dividing the two numbers) equals 0.25. 

To figure out the percentage, you just multiply the figure by 100, meaning the percentage is 25%.

Summary

While it may seem a bit confusing to begin with, working out the debt to asset ratio doesn’t have to be stressful but is relatively easy once you know how. Practice with several figures, and you’ll be able to figure it out automatically in no time at all!

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