# Total debt ratio

The total debt ratio is a financial metric that measures the proportion of a company’s assets that are financed by its total liabilities.
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Updated: May 31, 2024

## 3 key takeaways

• The total debt ratio indicates how much of a company’s assets are financed by debt.
• It is calculated by dividing total liabilities by total assets.
• A higher ratio suggests greater financial leverage and potential risk, while a lower ratio indicates more reliance on equity financing.

## What is the total debt ratio?

The total debt ratio, also known as the debt-to-assets ratio, is a financial metric used to assess the financial leverage of a company. It shows the proportion of a company’s assets that are financed through debt. This ratio provides insight into the financial structure of a company and its reliance on borrowed funds to finance its operations and growth.

A high total debt ratio indicates that a significant portion of the company’s assets is financed by debt, which can imply higher financial risk, especially if the company faces difficulties in meeting its debt obligations. Conversely, a low total debt ratio suggests that the company relies more on equity financing and has a lower level of financial risk.

## How to calculate the total debt ratio

The total debt ratio is calculated using the following formula:

Total Debt Ratio = Total Liabilities / Total Assets​

Where:

• Total Liabilities: The sum of all short-term and long-term liabilities of the company.
• Total Assets: The sum of all current and non-current assets of the company.

### Example Calculation:

If a company has:

• Total Liabilities: \$2 million
• Total Assets: \$5 million

Then the total debt ratio would be:

Total Debt Ratio = 2 million / 5 million = 0.4

This means that 40% of the company’s assets are financed by debt.

## Importance of the total debt ratio

The total debt ratio is an important indicator of a company’s financial health and risk profile. Here are several reasons why it is significant:

• Financial Leverage: It helps assess the extent of financial leverage a company is using. High leverage can amplify returns but also increases the risk of financial distress.
• Creditworthiness: Creditors and investors use the total debt ratio to evaluate the company’s ability to meet its debt obligations. A high ratio may indicate higher risk, affecting the company’s credit rating and borrowing costs.
• Financial Stability: It provides insight into the financial stability of a company. Companies with lower debt ratios are generally considered more financially stable.
• Investment Decisions: Investors use this ratio to make informed decisions about investing in a company. It helps them understand the company’s capital structure and risk level.

## Factors influencing the total debt ratio

Several factors can influence a company’s total debt ratio:

• Industry Norms: Different industries have varying levels of acceptable debt ratios. Capital-intensive industries may have higher debt ratios compared to service-oriented industries.
• Business Strategy: A company’s strategic decisions regarding growth, expansion, and capital structure can impact its debt ratio. Companies pursuing aggressive growth may take on more debt.
• Economic Conditions: Macroeconomic factors such as interest rates, economic growth, and market conditions can affect a company’s borrowing capacity and debt levels.
• Management Policies: The financial policies and risk tolerance of a company’s management team play a crucial role in determining the level of debt financing.

## Interpreting the total debt ratio

To effectively interpret the total debt ratio, consider the following:

• Comparison with Industry Peers: Compare the company’s total debt ratio with industry averages to gauge its relative financial leverage.
• Trend Analysis: Analyze the trend of the company’s debt ratio over time to understand changes in its financial leverage and risk profile.
• Other Financial Metrics: Consider other financial ratios, such as the debt-to-equity ratio, interest coverage ratio, and current ratio, to get a comprehensive view of the company’s financial health.

The total debt ratio is a valuable tool for assessing a company’s financial leverage and risk. By understanding this ratio, stakeholders can make more informed decisions regarding credit, investment, and management of financial resources.

Sources & references
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AI Financial Assistant
Arti is a specialized AI Financial Assistant at Invezz, created to support the editorial team. He leverages both AI and the Invezz.com knowledge base, understands over 100,000... read more.