How to calculate debt to asset ratio: tips and an example

By Indeed Editorial Team

Updated 17 June 2022 | Published 3 January 2022

Updated 17 June 2022

Published 3 January 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

When assessing the time the organisation has to lapse on the repayment of loans or other forms of debts, the debt to asset ratio is an essential metric that can help inform you of the financial strength of the organisation. Also, it may help you compare past ratios and the organisation's development rate within a particular period. Knowing the financial details necessary to deduce this ratio can help you compute the debt to asset ratio and evaluate the results. In this article, we illustrate how to calculate the debt to asset ratio and how to interpret your findings.

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What is the debt to asset ratio?

The debt to asset ratio is a metric that highlights an organisation's financial stability. You can use it to calculate the assets funded by the business's liabilities instead of its capital. You can also use this ratio to assess the organisation's development rate through the assets bought within a period. It's an essential tool an investor can use to assess if the organisation has the resources to pay impending debts and also the return on investments.

Also, the debt to asset ratio illustrates the percentage of the company's total assets funded by the creditors. You can calculate it by dividing the total value of debts or current liabilities by the total value the company has in assets. This can be short-term or long-term investments and capital assets. To compute the total liabilities, add both short-term and long-term debt together to get the total value in liabilities the business has an obligation to pay. The formula for calculating the debt to asset ratio is:

Debt to asset ratio = total liabilities / total assets

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How to calculate debt to asset ratio

When computing the debt to asset ratio, it's appropriate to begin by analysing the financial balance sheet of the company. It may also be useful to compute the ratio over the lifespan of the company, to have an elaborate view of the level of financial advancement or decline of the organisation. Here are some steps that explain how you can use the debt to asset formula to compute the ratio:

1. Calculate the total liabilities

The initial step you can take in calculating your debt to asset ratio is to compute all the existing liabilities of the company. You can get these values from the short-term and long-term debts besides other liabilities the company has accumulated in the business's lifespan. When you deduce this value, you can place it in the formula. For example, an organisation may decide to evaluate all the loans they have collected intending to repay, besides any financial assistance got from creditors by the organisation all through its existence.

2. Calculate the total assets

Following computing the total liabilities, you can compute the total value of the organisation's assets. These may be quick assets like cash equivalents or cash, long-term investments that have produced income for the organisation. After deducing this value, put it in its proper position in the debt to asset ratio formula.

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3. Put both values in the correct places in the formula

When you have computed the amounts of both values, input each of them in the debt to asset ratio formula. It entails dividing the total liabilities by the total amount in assets. For instance, if the total debt is X and the total assets is Y, you can place them in the order of X/Y.

4. Calculate the debt to asset ratio using the formula

Having placed the values in their correct positions in the formula, you can then compute the debt to asset ratio. Divide the total liabilities by the total assets and your answer is likely to emerge in a decimal format. Also, you can transform it to a percentage, which shows the per cent of liabilities that creditors or investors fund.

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Discerning the debt to asset ratio

After completing the calculation of the debt to asset ratio, you can then evaluate your answer. Typically, if it's higher than one, like 1.4, this can imply that the organisation's liabilities are more than its assets. In addition, a debt to asset ratio larger than one can also prove that its assets financed a huge portion of the company's debt. Bigger ratios often show that a company may be in a situation that can lead to a lapse in repaying their loans, especially if there is an increment in the interest rate.

A ratio that is lower in value than one, for example, 0.73, can show that the equity finances a significant fraction of the company's assets and that the possibility of defaulting loan payments or even declaring bankruptcy is very minimal. Also, you can represent the decimal 0.73 in a percentage format, implying that its assets cover 73% of the company's liabilities. Illustrating your findings in a percentage can make it easier to interpret and present to your employer, co-workers or the company's stakeholders.

Example of a debt to asset ratio

Knowing how to use this formula can be useful to you when your tasks require you to calculate this ratio, including effectively interpreting the answer you derive from your debt to ratio computations. This may also give you a better insight into making financial forecasts concerning the stock value of the company. In the example below, we compute the debt to asset ratio and then use the value of the answer to assess the likelihood of a business lapsing on loan repayment or the possibility of the business filing for bankruptcy:

The managing director of a medium-sized company wants to evaluate the debt to asset ratio of the business. As part of the finance department, you can help to complete this task by assessing the business's balance sheet to discover the total amount in debt and the total amount of assets. If the total debt of the company = £46,000, the total assets of the company = £100,000 and the total stockholder's equity = £54,000, you can then use the debt to asset ratio formula to calculate the percentage:

Total debt / total assets = £46,000 / £100,000 = 0.46 or 46%

According to the findings, this ratio shows that creditors or a loan funded the organisation's assets, while the business owners provided 54% of the organisation's asset costs. It also further shows that this business has a low risk of lapsing on loan repayment, which can be beneficial if the company seeks further loans for renovations, expansions, developing new products or other expenses the company may handle in the future. In addition to this analysis of the debt to asset ratio, the organisation may decide to compare the result to previous debt to asset ratios over time.

Tips for computing equations

Here are some tips that can serve as a checklist for you when you are calculating your debt to asset ratio:

Attention to detail

It's essential to pay attention to every little detail when you are solving your equations and analysing your results. A slight oversight may give you a result different from the correct one. For instance, a slight mistake in writing a numerical value like 500 instead of 5,000 or 0.05 instead of 0.5 can yield a different answer. Cross-checking your values before computing them may help you guard against any oversight and provide the correct answer which can enlighten you on the steps the company may take to lower its risk even more.

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Practice often

Your job may involve calculating debt to asset ratios for the company and practising in advance may help you perform better in your role. It can help you compute equations faster and easily discover what your findings suggest about the business's financial risk, with minimal supervision from your boss. You can research mathematical resources online regarding this kind of ratio and solve their practice questions or watch the tutorial videos. Also, studying case studies of how similar businesses in your industry compute their debt to asset ratio may give you a better insight into how you can go about it.

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