# Definition of debt ratio

## What is the debt ratio?

The debt ratio is a financial ratio that measures the extent of a company’s indebtedness. The debt ratio is defined as the ratio of total debt to total assets, expressed as a decimal number or as a percentage. It can be interpreted as the proportion of a company’s assets that are financed by debt.

A ratio greater than 1 shows that a considerable part of the debt is financed by assets. In other words, the business has more liabilities than assets. A high ratio also indicates that a company may be exposed to a risk of default on its loans if interest rates were to rise suddenly. A ratio less than 1 means that more of a company’s assets are financed by equity.

Key points to remember

• The debt ratio measures the amount of leverage used by a business in terms of total debt over total assets.
• A debt ratio above 1.0 (100%) means a business has more debt than assets, while a debt ratio below 100% means a business has more assets than debt. .
• Debt ratios vary widely from industry to industry depending on the capital intensity of the industry.

## The debt ratio formula is



Rate of endettement

=

Total debt

Total assets

begin {aligned} & text {Debt ratio} = frac { text {Total debt}} { text {Total assets}} end {aligned}

Rate of endettement=Total assetsTotal debt

## What does the debt ratio tell you?

The higher the debt ratio, the more indebted a company is, which implies greater financial risk. At the same time, leverage is an important tool that businesses use to grow, and many businesses are finding sustainable uses for debt.

Debt ratios vary widely across industries, with capital-intensive companies such as utilities and pipelines having much higher debt ratios than other industries such as the tech sector. For example, if a business has total assets of $100 million and total debt of$ 30 million, its debt-to-equity ratio is 30% or 0.3. Is this company in a better financial situation than a company with a debt ratio of 40%? The answer depends on the industry.

A debt ratio of 30% may be too high for an industry with volatile cash flow, in which most companies have little debt. A business with a high debt ratio relative to its peers would likely find it expensive to borrow and could end up in dire straits if circumstances change.

The hydraulic fracturing industry, for example, went through tough times starting in the summer of 2014 due to high debt levels and falling energy prices. Conversely, a debt level of 40% can be easily manageable for a business in an industry like utilities, where cash flow is stable and debt ratios are the norm.

A debt ratio greater than 1.0 (100%) tells you that a business has more debt than assets. Meanwhile, a debt ratio of less than 100% indicates that a business has more assets than debt. Used in conjunction with other measures of financial health, the debt-to-equity ratio can help investors determine how risky a business is.

Some sources define the debt ratio as total liabilities divided by total assets. This reflects a certain ambiguity between the terms “debt” and “liability” which depends on the circumstances. The debt ratio, for example, is closely related and more common than the debt ratio, but uses total liabilities as the numerator. In the case of the debt ratio, financial data providers calculate it using only long-term and short-term debt (including current portions of long-term debt), excluding liabilities. such as accounts payable, negative goodwill and “other”.

In the consumer loan and mortgage industry, two common debt ratios that are used to assess a borrower’s ability to repay a loan or mortgage are the gross debt service ratio and the debt ratio. total debt service.

The gross debt ratio is defined as the ratio of monthly housing costs (including mortgage payments, home insurance, and real estate costs) to monthly income, while the total debt service ratio is the ratio of monthly housing costs plus other debts such as car payments and monthly income credit card loans. Acceptable levels of the total debt service ratio, in percentage terms, range from the mid-30s to the low 40s.

## Can a debt ratio be negative?

If a business has a negative debt ratio, it would mean that the business has negative equity. In other words, the company’s liabilities outnumber its assets. In most cases, this is considered a very risky sign, indicating that the business may be in danger of bankruptcy. 