Conversely, the short-term debt ratio concentrates on obligations due within a year. This ratio provides a snapshot of a company’s short-term liquidity and its ability to meet immediate financial obligations using its most liquid assets. The higher the debt ratio, the more leveraged a 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. Acceptable levels of the total debt service ratio range from the mid-30s to the low-40s in percentage terms.

  1. It offers a comparison point to determine whether a company’s debt levels are higher or lower than those of its competitors.
  2. Firms whose ratio is greater than 1.0 use more debt in financing their operations than equity.
  3. Google is no longer a technology start-up; it is an established company with proven revenue models that is easier to attract investors.
  4. The debt ratio shows the overall debt burden of the company—not just the current debt.

He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. In addition, the reluctance to raise debt can cause the company to miss out on growth opportunities to fund expansion plans, as well as not benefit from the “tax shield” from interest expense. Dave’s Guitar Shop is thinking about building an addition onto the back of its existing building for more storage. Ask a question about your financial situation providing as much detail as possible. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications. Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others.

What is the Debt to Equity Ratio?

Other financial ratios and financial statements should be considered when evaluating a company’s overall financial health and performance. Debt ratio is a metric that measures a company’s total debt, as a percentage of its total assets. A high new politicians use of twitter can increase fundraising, attract new donors debt ratio indicates that a company is highly leveraged, and may have borrowed more money than it can easily pay back. Investors and accountants use debt ratios to assess the risk that a company is likely to default on its obligations.

Lenders often have debt ratio limits and do not extend further credit to firms that are overleveraged. Of course, there are other factors as well, such as creditworthiness, payment history, and professional relationships. Debt ratio provides insights into a company’s capital structure by showcasing the balance between debt and equity. Because of this, what is considered to be an acceptable debt ratio by investors may depend on the industry of the company in which they are investing. Stakeholders, especially creditors, may view a high debt ratio as an increased risk, potentially impacting the company’s borrowing costs and terms.

What is a Good Debt to Asset Ratio?

Therefore, the debt-to-equity ratio of XYZ Ltd stood at 0.40 as on December 31, 2018. Lenders and investors perceive borrowers funded primarily with equity (e.g. owners’ equity, outside equity raised, retained earnings) more favorably. The formula for calculating the debt-to-equity ratio (D/E) is as follows.


Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses.

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A company that has a debt ratio of more than 50% is known as a “leveraged” company. 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. 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. As with any ratio, the debt-to-equity ratio offers more meaning and insight when compared to the same calculation for different historical financial periods.

The opposite of the above example applies if a company has a D/E ratio that’s too high. In this case, any losses will be compounded down and the company may not be able to service its debt. For the remainder of the forecast, the short-term debt will grow by $2m each year, while the long-term debt will grow by $5m. It should be analyzed in comparison with competitors and together with other ratios such as times interest earned, etc. Both variables are reported on the balance sheet (statement of financial position). On the opposite end, Company C seems to be the riskiest, as the carrying value of its debt is double the value of its assets.

If you have a $50,000 loan and $10,000 is due this year, the $10,000 is considered a current liability and the remaining $40,000 is considered a long-term liability or long-term debt. When calculating the debt to equity ratio, you use the entire $40,000 in the numerator of the equation. In the financial industry (particularly banking), a similar concept is equity to total assets (or equity to risk-weighted assets), otherwise known as capital adequacy. By contrast, higher D/E ratios imply the company’s operations depend more on debt capital – which means creditors have greater claims on the assets of the company in a liquidation scenario. WFC has better debt ratios than JPM in all the four years except the most recent financial year. The ratio for both firms has stayed in a narrow range of 13-15% over the four-year period indicating little change in solvency of the companies.

What is Debt Ratio?

For instance, capital-intensive industries such as utilities or manufacturing might naturally have higher debt ratios due to significant infrastructure and machinery investments. Debt is considered riskier compared to equity since they incur interest, regardless of whether the company made income or not. Alternatively, if we know the equity ratio we can easily compute for the debt ratio by subtracting it from 1 or 100%.

Part 2: Your Current Nest Egg

Companies with lower debt ratios and higher equity ratios are known as “conservative” companies. For example, Google’s .30 total-debt-to-total-assets may also be communicated as 30%. The debt to equity ratio indicates how much debt and how much equity a business uses to finance its operations. For purposes of simplicity, the liabilities on our balance sheet are only short-term and long-term debt. In our debt-to-equity ratio (D/E) modeling exercise, we’ll forecast a hypothetical company’s balance sheet for five years. Lenders and debt investors prefer lower D/E ratios as that implies there is less reliance on debt financing to fund operations – i.e. working capital requirements such as the purchase of inventory.

Leveraged companies are considered riskier since businesses are contractually obliged to pay interests on debts regardless of their operating results. Even if a business incurs operating losses, it still is required to meet fixed interest obligations. In contrast, the payment of dividends to equity holders is not mandatory; it is made only upon the decision of the company’s board. The debt ratio is a financial leverage ratio that measures the portion of company resources (pertaining to assets) that is funded by debt (pertaining to liabilities). Common debt ratios include debt-to-equity, debt-to-assets, long-term debt-to-assets, and leverage and gearing ratios. In the consumer lending and mortgage business, two common debt ratios 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.