Total Debt To Total Assets

Definition of 'Total Debt To Total Assets'


Total debt to total assets is a leverage ratio that defines the total amount of debt relative to assets. This enables comparisons of leverage to be made across different companies. The higher the ratio, the higher the degree of leverage, and consequently, financial risk. This is a broad ratio that includes long-term and short-term debt (borrowings maturing within one year), as well as all assets – tangible and intangible.

Total Debt To Total Assets

Investopedia explains 'Total Debt To Total Assets'


For example, assume hypothetical company Levered Co. has $40 million in long-term debt, $10 million in short-term debt, and $100 million in total assets. Levered Co. would therefore have a total debt to total assets ratio of 0.5. On the other hand, if rival LowLevered Co. has $5 million in long-term debt, $5 million in short-term debt, and $50 million in total assets, its total debt to total assets ratio would be 0.2.

From the above example, 50% of Levered Co.’s assets have been financed by debt, while only 20% of LowLevered Co.’s assets were. Levered Co. has a much higher degree of leverage than LowLevered Co., and therefore a lower degree of financial flexibility.

This is because debt servicing payments have to be made under all circumstances, otherwise the company would breach debt covenants and run the risk of being forced into bankruptcy by creditors. While other liabilities such as accounts payable and long-term leases can be negotiated to some extent, there is very little “wiggle room” with debt covenants. Therefore, a company with a high degree of leverage may find it more difficult during a recession than one with low leverage. It should be noted that total debt measure does not include short-term liabilities like accounts payable and long-term liabilities such as capital lease and pension plan obligations. 

One shortcoming of the total debt to total assets ratio is that it does not provide any indication of asset quality, since it lumps all tangible and intangible assets together. Continuing from the above example, assume Levered Co. took on the $40 million of long-term debt to acquire a competitor, and booked $20 million as goodwill for this acquisition. Let’s say the acquisition does not perform as expected and results in all the goodwill being written off. In this case, the ratio of total debt to total assets (which amounts to $80 million) would be 0.63.

Like all other ratios, the trend of the total debt to total assets should also be evaluated over time. This will help assess whether the company’s financial risk profile is improving or deteriorating.

 


Filed Under: ,

comments powered by Disqus
Hot Definitions
  1. Genuine Progress Indicator - GPI

    A metric used to measure the economic growth of a country. It is often considered as a replacement to the more well known gross domestic product (GDP) economic indicator. The GPI indicator takes everything the GDP uses into account, but also adds other figures that represent the cost of the negative effects related to economic activity (such as the cost of crime, cost of ozone depletion and cost of resource depletion, among others).
  2. Accelerated Share Repurchase - ASR

    A specific method by which corporations can repurchase outstanding shares of their stock. The accelerated share repurchase (ASR) is usually accomplished by the corporation purchasing shares of its stock from an investment bank. The investment bank borrows the shares from clients or share lenders and sells them to the company.
  3. Microeconomic Pricing Model

    A model of the way prices are set within a market for a given good. According to this model, prices are set based on the balance of supply and demand in the market. In general, profit incentives are said to resemble an "invisible hand" that guides competing participants to an equilibrium price. The demand curve in this model is determined by consumers attempting to maximize their utility, given their budget.
  4. Centralized Market

    A financial market structure that consists of having all orders routed to one central exchange with no other competing market. The quoted prices of the various securities listed on the exchange represent the only price that is available to investors seeking to buy or sell the specific asset.
  5. Balanced Investment Strategy

    A portfolio allocation and management method aimed at balancing risk and return. Such portfolios are generally divided equally between equities and fixed-income securities.
  6. Negative Carry

    A situation in which the cost of holding a security exceeds the yield earned. A negative carry situation is typically undesirable because it means the investor is losing money. An investor might, however, achieve a positive after-tax yield on a negative carry trade if the investment comes with tax advantages, as might be the case with a bond whose interest payments were nontaxable.
Trading Center