How to Calculate the Debt Ratio

Debt Ratio Calculator

function calculateDebtRatio() { var totalLiabilities = parseFloat(document.getElementById('totalLiabilities').value); var totalAssets = parseFloat(document.getElementById('totalAssets').value); var resultDiv = document.getElementById('debtRatioResult'); if (isNaN(totalLiabilities) || isNaN(totalAssets) || totalLiabilities < 0 || totalAssets < 0) { resultDiv.innerHTML = "Please enter valid positive numbers for Total Liabilities and Total Assets."; return; } if (totalAssets === 0) { resultDiv.innerHTML = "Total Assets cannot be zero. Please enter a positive value."; return; } var debtRatio = (totalLiabilities / totalAssets) * 100; // As a percentage resultDiv.innerHTML = "Your Debt Ratio is: " + debtRatio.toFixed(2) + "%"; }

Understanding the Debt Ratio

The Debt Ratio is a fundamental financial metric used to assess a company's or individual's financial leverage. It indicates the proportion of assets that are financed by debt. In simpler terms, it tells you how much of your assets are owned by creditors versus how much you own outright.

What is the Debt Ratio?

The Debt Ratio is a solvency ratio that measures the extent of a company's or individual's leverage. It is calculated by dividing total liabilities by total assets. A higher ratio indicates that a larger portion of assets is financed by debt, which can imply higher financial risk.

How to Calculate the Debt Ratio

The formula for the Debt Ratio is straightforward:

Debt Ratio = Total Liabilities / Total Assets

The result is often expressed as a percentage to make it easier to interpret.

• Total Liabilities: This includes all current liabilities (e.g., accounts payable, short-term loans, accrued expenses) and long-term liabilities (e.g., mortgages, bonds payable, long-term loans).
• Total Assets: This includes all current assets (e.g., cash, accounts receivable, inventory) and non-current assets (e.g., property, plant, equipment, investments).

Why is the Debt Ratio Important?

The Debt Ratio is a critical indicator for several reasons:

• Risk Assessment: Lenders and investors use this ratio to gauge a company's or individual's ability to meet its financial obligations. A high debt ratio suggests higher risk, as the entity relies heavily on borrowed funds.
• Financial Health: It provides insight into the overall financial health and stability. A lower ratio generally indicates a more stable financial position.
• Decision Making: For businesses, it helps management understand their capital structure and make informed decisions about future borrowing or expansion. For individuals, it can help assess personal financial leverage.
• Benchmarking: It allows for comparison against industry averages or competitors to understand relative financial standing.

Interpreting the Debt Ratio

• Low Debt Ratio (e.g., below 0.5 or 50%): Generally considered favorable. It means that a significant portion of assets is financed by equity rather than debt, indicating lower financial risk and greater solvency.
• High Debt Ratio (e.g., above 0.5 or 50%): Suggests higher financial risk. The entity relies more on debt to finance its assets, which could lead to difficulties if revenues decline or interest rates rise. However, what constitutes "high" can vary significantly by industry.

Example of Debt Ratio Calculation

Let's consider a small business:

• Total Liabilities: $150,000 (e.g., $50,000 in short-term loans, $100,000 in a long-term mortgage)
• Total Assets: $500,000 (e.g., $50,000 cash, $100,000 inventory, $350,000 property)

Using the formula:

Debt Ratio = $150,000 / $500,000 = 0.30

Expressed as a percentage, the Debt Ratio is 30%. This indicates that 30% of the business's assets are financed by debt, which is generally considered a healthy and manageable level of leverage.

Use the calculator above to quickly determine your own or a company's debt ratio by inputting the total liabilities and total assets.