Debt Ratio

Loading the player...

What is a 'Debt Ratio'

A financial ratio that measures the extent of a company’s or consumer’s leverage. The debt ratio is defined as the ratio of total – long-term and short-term – debt to total assets, expressed as a decimal or percentage. It can be interpreted as the proportion of a company’s assets that are financed by debt.

Also referred to as the debt-to-assets ratio.

BREAKING DOWN 'Debt Ratio'

The higher this ratio, the more leveraged the company is, implying greater financial risk. At the same time, leverage is an important tool that companies use to grow, and many businesses find sustainable uses for debt. 

Debt ratios vary widely across industries, with capital-intensive businesses such as utilities and pipelines having much higher debt ratios than other industries like technology. For example, if a company has total assets of $100 million and total debt of $30 million, its debt ratio is 30% or 0.30. Is this company in a better financial situation than one with a debt ratio of 40%? The answer depends on the industry.

A debt ratio of 30% may be too high for an industry with volatile cash flows, in which most businesses take on little debt. A company with a high debt ratio relative to its peers would probably find it expensive to borrow and could find itself in a crunch if circumstances change. The fracking​ industry, for example, experienced tough times beginning in the summer of 2014, brought on by high levels of debt and plummeting energy prices.

Conversely, a debt level of 40% may be easily manageable for a company in a sector such as utilities, where cash flows are stable and higher debt ratios are the norm.

A debt ratio of greater than 100% tells you that a company has more debt than assets. Meanwhile, a debt ratio of less than 100% indicates that a company has more assets than debt. Used in conjunction with other measures of financial health, the debt ratio can help investors determine a company's risk level.

Some sources define the debt ratio as total liabilities divided by total assets. This reflects a certain ambiguity between the terms "debt" and "liabilities" that depends on the circumstance. The debt-to-equity ratio, for example, is closely related to and more common than the debt ratio, but uses total liabilities in the numerator. In the case of the debt ratio, financial data providers calculate it using only long-term and short-term debt (including current portions of long-term debt), excluding liabilities such as accounts payable, negative goodwill and "other." The debt ratio is often called the "debt-to-assets ratio."

Let's look at a few examples from different industries to contextualize the debt ratio. Starbucks Corp. (SBUX) listed $549,800,000 in short-term and current portion of long-term debt on its balance sheet for the quarter ending June 28, 2015, and $2,347,400,000 in long-term debt. The company's total assets were $12,868,800,000. This gives us a debt ratio of (549,800,000 + 2,347,400,000) ÷ 12,868,800,000 = 0.2251, or 22.51%.

To assess whether this is high, we should consider the capital expenditures that go into opening a Starbucks: leasing commercial space, renovating it to fit a certain layout, and purchasing expensive specialty equipment, much of which is used infrequently. The company must also hire and train employees in an industry with exceptionally high employee turnover, adhere to food safety regulations, etc. for 21,000 locations, in 65 countries. Perhaps 23% isn't so bad after all, and indeed Morningstar gives the industry average as 40%. 

The result is that Starbucks has an easy time borrowing money; creditors trust that it is in a solid financial position and can be expected to pay them back in full. Fixed-rate, non-callable Starbucks bonds with a maturity date in 2045 have a coupon rate of 4.3%.

What about a technology company? For the quarter ending June 30, 2015, Facebook Inc. (FB) reported its short-term and current portion of long-term debt as $221,000,000; its long-term debt was $110,000,000; its total assets were $44,130,000,000. (221,000,000 + 110,000,000) ÷ 44,130,000,000 = 0.0075, or 0.75%. Facebook does not borrow on the corporate bond market. It has an easy enough time raising capital through stock.

Finally, let's look at a basic materials company, the St. Louis-based miner Arch Coal Inc. (ACI). For the quarter ending June 30, 2015, the company posted short-term and current portions of long-term debt of $31,763,000, long-term debt of $5,114,581,000 and total assets of $8,036,355,000. Coal mining is extremely capital-intensive, so the industry is forgiving of leverage: the average debt ratio is 47%. Even in this cohort, though, Arch Coal is heavily indebted; its debt ratio is 64%. Predictably, this makes borrowing expensive. Arch Coal's fixed, non-callable bonds with a maturity date in 2023 carry a hefty coupon rate of 12.0%

In the consumer lending and mortgages business, two common debt ratios are used to assess a borrower’s ability to repay a loan or mortgage are the gross debt service ratio and the total debt service ratio. The gross debt ratio is defined as the ratio of monthly housing costs (including mortgage payments, home insurance and property costs) to monthly income, while the total debt service ratio is the ratio of monthly housing costs plus other debt such as car payments and credit card borrowings to monthly income. Acceptable levels of the total debt service ratio, in percentage terms, range from the mid-30s to the low-40s.

RELATED TERMS
  1. Leverage Ratio

    Any ratio used to calculate the financial leverage of a company ...
  2. Long Term Debt To Total Assets ...

    A measurement representing the percentage of a corporation's ...
  3. Total Debt To Total Assets

    Total Debt To Total Assets is a measure of financial risk that ...
  4. Debt/Equity Ratio

    Debt/Equity Ratio is debt ratio used to measure a company's financial ...
  5. Debt-To-Capital Ratio

    A measurement of a company's financial leverage, calculated as ...
  6. Net Debt To EBITDA Ratio

    A measurement of leverage, calculated as a company's interest-bearing ...
Related Articles
  1. Investing

    Total Debt to Total Assets

    Total Debt to total assets, also called the debt ratio, is an accounting measurement that shows how much of a company’s assets are funded by borrowing. In business, borrowing is also called leverage.
  2. Investing Basics

    Understanding Leverage Ratios

    Large amounts of debt can cause businesses to become less competitive and, in some cases, lead to default. To lower their risk, investors use a variety of leverage ratios - including the debt, ...
  3. Credit & Loans

    Debt Ratios: Introduction

    By Richard Loth (Contact | Biography)The third series of ratios in this tutorial are debt ratios. These ratios give users a general idea of the company's overall debt load as well as its mix ...
  4. Credit & Loans

    Debt Ratios: The Debt Ratio

    By Richard Loth (Contact | Biography)The debt ratio compares a company's total debt to its total assets, which is used to gain a general idea as to the amount of leverage being used by a company. ...
  5. Active Trading Fundamentals

    Analyzing Oracle's Debt Ratios in 2016 (ORCL, SAP)

    Learn how the debt ratio, debt-to-equity ratio and debt-to-capital ratio are used to evaluate Oracle Corp.'s liabilities, equity and assets.
  6. Investing Basics

    4 Leverage Ratios Used In Evaluating Energy Firms

    Analysts use specific leverage ratios to compare firms within an industry. A basic understanding of these ratios helps when evaluating oil and gas stocks.
  7. Investing Basics

    Will Corporate Debt Drag Your Stock Down?

    Borrowed funds can mean a leg up for companies or the boot for investors. Find out how to tell the difference.
  8. Active Trading Fundamentals

    Analyzing General Electric's Debt Ratios in 2016 (GE)

    Evaluate GE's debt picture using the most important metrics for a large-cap conglomerate, including the debt-to-equity (D/E) ratio and the interest coverage ratio.
  9. Credit & Loans

    Debt Ratios: Capitalization Ratio

    By Richard Loth (Contact | Biography)The capitalization ratio measures the debt component of a company's capital structure, or capitalization (i.e., the sum of long-term debt liabilities and ...
  10. Investing Basics

    Analyze Investments Quickly With Ratios

    Make informed decisions about your investments with these easy equations.
RELATED FAQS
  1. What is a good debt ratio, and what is a bad debt ratio?

    Learn about the factors that influence how investors and lenders evaluate the debt ratio for a company and why the answer ... Read Answer >>
  2. Over what duration should I be evaluating a company's total debt to total assets ...

    Learn what duration to use when analyzing the total debt to total assets ratio in a company and how to track a company's ... Read Answer >>
  3. What is the difference between debt to income and debt to assets?

    Understand the differences between the debt-to-income ratio and the debt to assets ratio as they apply to personal and corporate ... Read Answer >>
  4. Does a high debt to capital ratio make a company a bad investment?

    Understand the debt to capital ratio and why a high debt to capital ratio doesn't necessarily mean that a stock is a bad ... Read Answer >>
  5. What are the different capitalization ratios?

    Learn about capitalization ratios, three different ratios that measure debt in relation to capital structure and how to calculate ... Read Answer >>
  6. What is the most widely used gearing ratio?

    Understand the most commonly used gearing, or leverage, ratio used to evaluate a company's financial condition, the debt ... Read Answer >>
Hot Definitions
  1. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  2. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  3. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  4. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  5. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  6. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
Trading Center