Debt to Asset Ratio

Debt to Asset Ratio is a leverage ratio calculated by dividing a company's total debt by total assets. D/A Ratio measures the firm’s financial risk and leverage.

What is Debt to Asset Ratio?

The Debt to Asset Ratio is a financial metric that shows total debt divided by total assets. The metric is also referred to as Total Debt to Total Assets Ratio, Debt/Asset Ratio, Debt Ratio, and D/A Ratio. D/A ratio is a leverage ratio used to understand the risk of a company.

The debt to asset ratio formula is:

D/A Ratio Formula = (Short-Term Debt + Long-Term Debt) / (Current Assets + Noncurrent Assets)

D/A Ratio Formula = Total Debt / Total Assets

The debt to asset ratio formula is total debt divided by total assets. Both of these values are found on the balance sheet.

The numerator is total debt. This refers to the financial obligations that a company has to vendors, suppliers, and creditors.

Total debt is an account on the company’s balance sheet and can be further broken down into short-term debt and long-term debt.

The numerator is total assets, which is the sum of all assets on a company’s balance sheet. Total assets can be further broken down to current assets and noncurrent assets.

Current assets include cash, short-term investments, accounts receivable, inventory, and office supplies. Noncurrent assets include fixed assets (factories, equipment, vehicles), intangible assets (trademarks, patents, goodwill), and long-term investments (stocks and bonds).

Debt to Asset Ratio Definition

D/A ratio shows what portion of a company’s assets are financed by debt.

The debt to asset ratio formula is:

D/A Ratio Formula = Total Debt / Total Assets

A company’s assets are productive resources that must be financed either through equity (selling shares in the company), debt (borrowing money from lenders), or profit.

Businesses in different industries will have a different mix of debt and equity in their capital structure. That said, D/A ratio is a helpful tool for any operator to keep a close eye on their total amount of debt in their business.

In addition to tracking the debt/asset ratio, we recommend teams keep close track of when their borrowings mature so they maintain an adequate cash balance.

Companies with a higher D/A ratio have higher risk, whereas companies with a lower D/A ratio have lower risk. A company with a 0.0x D/A ratio would have no debt.

Company management, investors, and creditors will look to the debt/asset ratio to understand how a company is funding its assets. A debt/asset ratio that is too low might mean that the company is missing out on an opportunity to lower their cost of capital.

Meanwhile, a D/A ratio that is too high could mean a company has too many debt obligations and is an indication of a company that’s too risky.

Debt to Asset Ratio Example

Here are two examples that walk through the debt to asset calculations for Company A in the fiscal year 2021.

Company A, Fiscal Year 2021

  • Current Assets: $1,000,000
  • Noncurrent Assets: $1,200,000
  • Short-Term Debt: $900,000
  • Long-Term Debt: $1,000,000

Let’s use the debt to asset formula from above.

D/A Ratio = Total Debt / Total Assets

D/A Ratio = ($900,000 + $1,000,000) / ($1,000,000 + $1,200,000)

D/A Ratio = $1,900,000 / $2,200,000

D/A Ratio = 0.86x

Now let’s see what happens if Company A adds a $100,000 short-term business loan to accelerate growth and further develop the firm’s operations.

Company A, Fiscal Year 2021

  • Current Assets: $1,100,000
  • Noncurrent Assets: $1,200,000
  • Short-Term Debt: $1,000,000
  • Long-Term Debt: $1,000,000

Here is the debt to asset calculation after the additional debt.

D/A Ratio = Total Debt / Total Assets

D/A Ratio = ($1,000,000 + $1,000,000) / ($1,100,000 + $1,200,000)

D/A Ratio = $2,000,000 / $2,300,000

D/A Ratio = 0.87x

Taking on the $100,000 of debt increased our liabilities but it also added $100,000 to our cash balance, changing both the numerator and denominator.

Solvency Ratios

A solvency ratio is a financial metric that shows a company’s ability to meet its long-term financial obligations. Examples of solvency ratios include debt to asset ratio, debt to capital ratio, debt to equity ratio, and interest coverage ratio.
A set of related metrics are liquidity ratios, including current ratio, quick ratio, and cash ratio. Liquidity ratios highlight a company’s ability to meet its short-term financial obligations. Next, we are going to explore debt to equity and interest coverage ratio.

Debt to Capital Ratio

Debt to capital compares a company’s total debt balance to all capital in the business.

The debt/capital formula is:

Debt/Capital Ratio = Total Debt / (Total Debt + Common Equity + Preferred Equity)

Debt/Capital Ratio = Total Debt / (Total Debt + Total Equity)

This leverage ratio is helpful to understand the capitalization of a business.

Debt to Equity Ratio

Debt to equity compares a company’s total debt balance to its total shareholders’ equity.

The debt/equity formula is:

Debt/Equity Ratio = Total Debt / (Common Equity + Preferred Equity)

Debt/Equity Ratio = Total Debt / Total Shareholders’ Equity

This leverage ratio shows the split between interest-bearing debt and total equity.

Interest Coverage Ratio

Interest coverage ratio (ICR) shows how many times a company’s profit covers its interest expense.

The interest coverage ratio formula is:

Interest Coverage Ratio = Operating Profit / Interest Expense

Interest Coverage Ratio = Earnings Before Interest and Taxes / Interest Expense

These calculations lead to the same result because operating profit is another word for earnings before interest and tax (EBIT).

Understanding Company Leverage

In the business world, leverage refers to how much debt a company has taken on in an attempt to improve operations. A company’s debt should be used to fund the purchase of productive assets.

Borrowing money at 4% per year is productive if it can be used to generate a return of 8% or 10% per year. However, that must be balanced against not having too many interest payments that harm the cash flow of the business.
Ultimately, what is deemed a good debt ratio or a bad debt ratio will vary by industry. For example, a small consulting firm might have almost no debt whereas large manufacturing or financial services companies might have considerable amounts.
It’s important for stakeholders of all types to understand an appropriate amount of leverage for the situation. Debt/equity, debt/asset, and debt/capital are helpful metrics that show how a company is progressing over time or versus competitors in the space.

For instance, Bank of America had a debt/equity ratio of 2.23x in Q1 2010, up from 1.30x in Q1 2008. This is an alarming growth in leverage in two years.

If a company has too much debt, it could lead to higher interest rates on future borrowings, a poor cash position, or (in the worst case) bankruptcy. Managers should receive their debt levels on a monthly basis to ensure the company is financially viable.

The debt to asset ratio is a leverage ratio.

Final Thoughts

Debt/asset ratio is a financial ratio that compares a company’s total debt to the total amount of assets. It shows how much debt has been used to finance a company’s assets.

The formula is total debt divided by total assets and related metrics include debt/equity and debt/capital.

Small business owners, executives, analysts, and creditors all look to D/A ratio to better understand the overall risk of a company. Managers will look to fund assets with the cheapest source of capital while managing their risk.

For example, an ecommerce company would benefit from purchasing inventory in bulk. They could raise additional capital to purchase more inventory, which would reduce their cost of goods sold.
However, a higher degree of leverage is not always a good thing. Management should keep an eye on the current amount of debt and how that compares to the company’s profitability, average cash balance, and the industry average.

That’s why these debt ratios are important to track.

That said, the debt to asset ratio has some shortcomings as well. The default version of the formula combines tangible assets (like factories, equipment, and vehicles) and intangible assets (like trademarks, patents, and goodwill).

It might be more helpful to compare total debt to tangible assets. Variations of formulas are common to provide a specific view into a business. This is where management’s discretion and expertise comes into play.

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