Total-Debt-to-Total-Assets Ratio: Meaning, Formula, and What's Good

What Is the Total-Debt-to-Total-Assets Ratio?

Total-debt-to-total-assets is a leverage ratio that defines how much debt a company owns compared to its assets. Using this metric, analysts can compare one company's leverage with that of other companies in the same industry. This information can reflect how financially stable a company is. The higher the ratio, the higher the degree of leverage (DoL) and, consequently, the higher the risk of investing in that company.

Understanding the Total-Debt-to-Total-Assets Ratio

The total-debt-to-total-assets ratio analyzes a company's balance sheet. The calculation includes long-term and short-term debt (borrowings maturing within one year) of the company. It also encompasses all assets—both tangible and intangible. It indicates how much debt is used to carry a firm's assets, and how those assets might be used to service debt. It, therefore, measures a firm's degree of leverage.

Debt servicing payments must be made under all circumstances, otherwise, the company would breach its 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.

A company with a high degree of leverage may thus find it more difficult to stay afloat during a recession than one with low leverage. It should be noted that the total debt measure does not include short-term liabilities such as accounts payable and long-term liabilities such as capital leases and pension plan obligations.

Total-Debt-to-Total-Assets Formula

The total-debt-to-total-assets formula is the quotient of total debt divided by total assets. As shown below, total debt includes both short-term and long-term liabilities. All company assets, including short-term, long-term, capital, tangible, or other.

$\begin{aligned} &\text{TD/TA} = \frac{ \text{Short-Term Debt} + \text{Long-Term Debt} }{ \text{Total Assets} } \\ \end{aligned}$​TD/TA=Total AssetsShort-Term Debt+Long-Term Debt​​

If the calculation yields a result greater than 1, this means the company is technically insolvent as it has more liabilities than all of its assets combined. More often, the total-debt-to-total assets ratio will be less than one. A calculation of 0.5 (or 50%) means that 50% of the company's assets are financed using debt (with the other half being financed through equity).

What Does the Total-Debt-to-Total-Assets Ratio Tell You?

Total-debt-to-total-assets is a measure of the company's assets that are financed by debt rather than equity. When calculated over a number of years, this leverage ratio shows how a company has grown and acquired its assets as a function of time.

Investors use the ratio to evaluate whether the company has enough funds to meet its current debt obligations and to assess whether the company can pay a return on its investment. Creditors use the ratio to see how much debt the company already has and whether the company can repay its existing debt. This will determine whether additional loans will be extended to the firm.

A ratio greater than 1 shows that a considerable portion of the assets is funded by debt. In other words, the company has more liabilities than assets. A high ratio also indicates that a company may be putting itself at risk of defaulting on its loans if interest rates were to rise suddenly.

A ratio below 0.5, meanwhile, indicates that a greater portion of a company's assets is funded by equity. This often gives a company more flexibility, as companies can increase, decrease, pause, or cancel future dividend plans to shareholders. Alternatively, once locked into debt obligations, a company is often legally bound to that agreement.

Real-World Example of the Total-Debt-to-Total-Assets Ratio

Let's examine the total-debt-to-total-assets ratio for three companies:

• Alphabet, Inc. (Google), as of its fiscal quarter ending March 31, 2022.
• Costco Wholesale, as of its fiscal quarter ending May 8, 2022.
• Hertz Global Holdings, as of its fiscal quarter ending March 31, 2022.

From the example above, the companies are ordered from highest degree of flexibility to lowest degree of flexibility.

• Google is not weighed down by debt obligations and will likely be able to secure additional capital at potentially lower rates compared to the other two companies. Although its debt balance is more than three times higher than Costco, it carries proportionally less debt compared to total assets compared to the other two companies.
• Costco has been financed nearly evenly split between debt and equity. This means the company carries roughly the same amount of debt as it does in retained earnings, common stock, and net income.
• Hertz is relatively known for carrying a high degree of debt on its balance sheet. Although its debt balance is smaller than the other two companies, almost 90% of all the assets it owns are financed. Hertz has the lowest degree of flexibility of these three companies as it has legal obligations to fulfill (whereas Google has flexibility regarding dividend distributions to shareholders).

It's also important to understand the size, industry, and goals of each company to interpret their total-debt-to-total-assets. Google is no longer a technology start-up; it is an established company with proven revenue models that is easier to attract investors. Meanwhile, Hertz is a much smaller company that may not be as enticing to shareholders. Hertz may find the demands of investors are too great to secure financing, turning to financial institutions for its capital instead.

Limitations of the Total-Debt-to-Total-Assets Ratio

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, in the example above, Hertz is reporting $2.9 billion of intangible assets, $611 million of PPE, and $1.04 billion of goodwill as part of its total $20.9 billion of assets. Therefore, the company has more debt on its books than all of its current assets. Should all of its debts be called immediately by lenders, the company would be unable to pay all its debt, even if the total-debt-to-total-assets ratio indicates it might be able to.

As with all other ratios, the trend of the total-debt-to-total-assets ratio should 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 in the future.

The Bottom Line

The total-debt-to-total-assets ratio compares the total amount of liabilities of a company to all of its assets. The ratio is used to measure how leveraged the company is, as higher ratios indicate more debt is used as opposed to equity capital. To gain the best insight into the total-debt-to-total-assets ratio, it's often best to compare the findings of a single company over time or compare the ratios of different companies.