What is the debt-to-asset ratio?

Debt-to-asset ratio defined

A company’s debt-to-asset ratio shows what percentage of its assets is funded by interest-bearing debt, or liabilities. The ratio does not include any funding from the company’s suppliers or shareholders. You may also see it simply referred to as the debt ratio.

A company’s debt-to-asset ratio shows how much of its holdings, such as cash, real estate or equipment, is paid for with borrowed money. A higher number means the company owes more compared to what it owns, while a lower number shows it owes less.

“This is another type of leverage ratio. Debt-to-asset is simply total debt divided by the total assets, and it indicates the percentage of its assets that are funded by debt,” explained Adam McDiarmid, president of the small and medium business group at UMB Bank.

What is a good debt-to-asset ratio?

The debt-to-asset ratio looks different for each company and depends on what the industry norm is and where it is in the lifecycle of a company. In general though, any company with a ratio of one may be considered too risky, because it indicates a high level of debt versus what it owns, which may not be stable over the long term.

“Similar to the debt-to-equity ratio, this ratio needs to be compared to peers in the same industry to determine an appropriate ratio. If the ratio exceeds one, then it means that there are more liabilities than there are assets. Depending on the circumstances this figure could be an indication of insolvency,” added McDiarmid.

Having a higher debt-to-asset ratio can signal to investors or bankers that your company will only qualify for loans with higher interest rates, since a higher debt-to-asset ratio can indicate greater financial risk.

» MORE: What is a debt management plan?

The debt-to-asset formula

You can calculate a company’s debt-to-asset ratio, but it requires having the balance sheet in front of you first.

Once you have the balance sheet, locate the company’s current and long-term liabilities. Liabilities can include loans, bonds or other forms of debt. Sum up all of the liabilities for the total debt number.

Next, add up the company assets. This includes all current assets, including cash, receivables and inventory. It also includes non-current assets, such as real estate or equipment. Adding these together gives you the total assets number.

Lastly, divide the total debts by the total assets, and you’ll have the debt-to-asset ratio, or percentage.

 » READ: What is debt forgiveness?

Debt-to-asset ratio vs. debt-to-equity ratio

A company’s debt-to-equity ratio refers to how much equity a company has for every dollar of debt it holds. While the debt-to-asset ratio shows how much of the company’s assets are financed by debt, the debt-to-equity ratio compares how much debt the company has versus the amount of shareholder equity.

Investors and bankers use both ratios when analyzing a company’s financial risk, but each does so in a different way. Like debt-to-asset ratios, bankers and investors pay close attention to this number when a company applies for financing because it’s another signal for potential risk.

Having a higher debt-to-equity ratio implies greater reliance on debt financing, which can look riskier for investors. However, having a lower ratio can suggest the company uses a more conservative approach to financing by relying on equity.

» MORE: What is debt collection and how does it work?

Bottom line

Investors turn to indicators such as the debt-to-asset ratio when assessing a company’s overall financial health or risk. To find the number, you add up the company’s total debts and divide it by the company’s total assets.

With this information in hand, an investor or banker can quickly assess how much leverage a company holds. If a company must borrow money in the future, then having a lower debt-to-asset ratio can show the company’s not as risky and may even qualify for more competitive interest rates with a loan.