Debt ratio is also known as debt to assets or debt to capital ratio. It shows the proportion of a company’s total debt relative to its assets. This measure gives an idea as to the leverage of the company along with the potential risks the company faces in terms of its debt-load.
The amount of leverage, that is, debt that is right for the company varies based on the industry in which the company operates and the maturity of the company as well as other factors. What is optimal for one company might not be right for another. However, lower debt and higher equity levels generally indicate lower risk for the investors. The debt ratio can be compared to the industry average, to other companies, or trended over time to see how a company is doing managing its debt.
Formula for Debt ratio or Debt to asset ratio or Debt to capital ratio
\[Debt\,ratio = \frac{{Total\,liabilities}}{{Total\,assest}}\]
Example
Sun Pharma has total liabilities in the amount of Rs.79,930 and total assets in the amount of Rs1,32,000. This gives a debt ratio of 0.61. This means that 61% of the company’s assets are financed by the creditors and debt, and therefore 39% is financed by the owners (equity). A higher percentage indicates more leverage and more risk.
