This may be one of the easier calculations to actually compute, but it’s important to understand what you are computing. The formula requires two main parts – total debt and total assets. Total debt includes all current portions of long-term debt, short-term debt, and long-term debt. Keep in mind that this is different than simply total liabilities of a company. Total assets includes all assets, including intangibles. The formula is shown below:
- TotalDebt = all current, short-term, and long-term debt
- TotalAssets = all assets, both tangible and intangible
Debt Ratio Example:
Suppose XYZ Corp. has $25,000 in the current portion of long-term debt, $0 in short-term debt, and $75,000 in long-term debt. The company also has $300,000 in total assets. So, total debt = $100,000, and total assets = $300,000. This means that XYZ Corp. has a debt ratio of 0.333 ($100,000 / $300,000).
When looking at this ratio, it is important to keep in mind capital expenditures and cash flows. Also, look at industry averages in order to make a comparison. If XYZ’s industry average is 40%, then XYZ is less leveraged than most of its peers, and creditors will likely offer XYZ lower interest rates, since the company is likely to pay off its debt.