What is 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 metric enables comparisons of leverage to be made across different companies. The higher the ratio, the higher the degree of leverage (DoL) and, consequently, financial risk. The total debt to total assets 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
BREAKING DOWN Total Debt to Total Assets
Total debt to total assets is a measure of the company's assets that are financed by debt, rather than equity. This leverage ratio shows how a company has grown and acquired its assets over time. Investors use the ratio to not only evaluate whether the company has enough funds to meet its current debt obligations, but to also assess whether the company can pay a return on their investment. Creditors use the ratio to see how much debt the company already has and if the company has the ability to repay its debt, which will determine whether additional loans will be extended to the firm.
Practical Example of the Total Debt to Total Assets Ratio
Let's examine the total debt to total assets ratio for three companies - The Walt Disney Company, Chipotle Mexican Grill, Inc., and Sears Holdings Corporation - for the fiscal year ended 2017 (December 31, 2016 for Chipotle).
|(data in millions)||Disney||Chipotle||Sears|
|Total Debt to Assets||0.5302||0.3078||1.4085|
Interpreting the Total Debt to Total Assets Ratio
A ratio greater than 1 shows that a considerable portion of debt is funded by assets. In other words, the company has more liabilities than assets. A high ratio also indicates that a company may be putting itself at a risk of default on its loans if interest rates were to rise suddenly. A ratio below 1 translates to the fact that a greater portion of a company's assets is funded by equity.
From the example above, Sears has a much higher degree of of leverage than Disney and Chipotle, and therefore, a lower degree of financial flexibility. With more than $13 billion in total debt, there is a high chance of Sears declaring bankruptcy in the following months. Investors and creditors will consider Sears a risky company to invest in and loan to due to its very high leverage.
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 to stay afloat during a recession than one with low leverage. It should be noted that total debt measure does not include short-term liabilities such as 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. For example, assume Disney took on $50.8 billion of long-term debt to acquire a competitor, and booked $20 billion 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 would now be $95.8 billion - $20 billion = $75.8 billion) would be 0.67.
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. For example, an increasing trend indicates that a business is unwilling or unable to pay down its debt, which could indicate a default at some point in the future.