Debt to total assets ratio
| Debt to total assets ratio |
|---|
| See also |
Total debt to total assets ratio is one of leverage ratios, that presents the percentage of the share of the creditors to the total assets of the business. It is calculated by dividing total liabilities to total assets[1]. Assets take into account current and non- current assets of a company, as debts include both current liabilities and long-term liabilities. Enterprises endeavor to obtain low result of this ratio, because it means that the owners have more claims to the assets of the company than creditors[2].
Leverage Ratios
Leverage ratios according to M. Pozolli and F. Paolone “is any one of several financial measurements that look at how much capital comes in the form of debt (loans) or assesses the ability of a company to meet its financial obligations” [3]. These ratios are often called long-term solvency ratios [4].
The category of leverage ratio is important because companies finance their operations using a mix of equity and debt, and knowing the amount of debt held by the company is useful in assessing whether it can repay its debt on time [5]. Knowing the amount of debt which is held by the company is useful in assessing, if it can repay its debt on time.
How to calculate Total Debt to Total Assets ratio?
The formula is:
How to Use the Total Debt to Total Assets Ratio?
Let's have a look at the total debt to total assets ratio for three companies – Company X, Company Y, Company Z - for the end of fiscal year, 2018.
| The data is presented in millions of USD | Company X | Company Y | Company Z |
|---|---|---|---|
| Total Debt | 49,889 | 672.5 | 14,268 |
| Total Assets | 96.541 | 2265.15 | 10,256 |
| Total Debt to Assets | 0.52 | 0.29 | 1.39 |
From the provided example, Company Z has a much higher degree of leverage, than Company X and Company Y, so as the results this Company has a lower degree of financial flexibility. Such a financial situation (high level of indebtedness) may lead to the declaration of bankruptcy. Investors and creditors may consider such a company risky because it invests and borrows due to very high leverage.
Conclusions:
- Ratio's result higher than 1, presents that a company has more liabilities than assets, i.e. a significant part of the debt is funded by assets.
- A high ratio may mean that an enterprise may run the risk of default on its loans, if interest rates suddenly increase.
- A ratio below 1 presents that the major part of the company's assets is funded by equity.
Footnotes
References
- Agatrap- San Juan D. (2007), Fundamentals of Accounting: Basic Accounting Principles Simplified for Accounting Students, AuthorHouse, Bloomington, p. 331-337
- Buljevich E., Park Y. (1999), Project Financing and the International Financial Markets, Springer Science & Business Media, Norwell, p. 133-138
- Colla P., Ippolito F., Kai L. (2013), Debt specialization, "The Journal of Finance", No. 68.5, p. 2117-2141
- Lin C., Ma Y., Malatesta P., Xuan Y. (2013), Corporate ownership structure and the choice between bank debt and public debt, "Journal of Financial Economics", No. 109(2), p. 517-534
- Nikolai L., Bazley J., Jefferson J. (2010)., Intermediate Accounting, Eleventh Edition, Cengage Learning, Mason, p. 284-285
- Parrino R., Kidwell D., Bates T. (2011), Fundamentals of Corporate Finance 2nd Edition, John Wiley & Sons, Haboken, p. 93-96
- Pozzoli M., Paolone F. (2017), Corporate Financial Distress: A Study of the Italian Manufacturing Industry, Springer, Naples, p. 30-33
- Van der Wijst N., Thurik R. (1993), Determinants of small firm debt ratios: An analysis of retail panel data, "Small Business Economics", No. 5.1, p. 55-65
- Welch I. (2011), Two common problems in capital structure research: The financial‐debt‐to‐asset ratio and issuing activity versus leverage changes, "International Review of Finance", No. 11(1), p. 1-17
Author: Katarzyna Skrzyniarz
