A company's debt ratio: How to interpret it?
Posted: Wed Dec 18, 2024 5:11 am
Among the financial indicators or ratios also popularly known in the financial environment as KPI (Key Performance Indicators), one of the most used is the debt ratio.
We explain what the debt ratio is and the different types of debt ratios that you can use.
Learn in this article how to interpret it and its formula to calculate it.
Excessive debt is one of the main reasons why many companies end up closing their doors. To know when debt levels start to become alarming, the debt ratio is used.
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This ratio is often used together with other financial indicators to perform a complete analysis of the financial statements in a given period. This analysis will allow a financial diagnosis of the company to be made, which will allow us to know, among other things:
The financial strengths and weaknesses of the company.
Your level of debt.
Compare the company's situation with other periods or companies in the sector.
The debt ratio is usually transferred together with the main financial indicators to a dashboard for easy consultation by company managers.
Companies that are most concerned about maintaining control of their business at all times use applications that generate dashboards with the main ratios in an automated manner .
Download the FREE guide “The art of getting paid (on time)”
1) What is the debt ratio?
The debt ratio is a financial indicator that allows us to know the proportion of debt that a company has in relation to the assets it has .
Thanks to this ratio, you can determine your dependence on external financing and whether your business is excessively indebted.
Debt is recorded as a liability on the balance sheet and refers to all payments that a company must make in the long and short term.
The debt ratio is an indicator of the company's financial structure, as it relates its own and external resources.
2) What is the debt ratio formula?
To calculate the debt ratio, the net value of the company's equity must be related to the fixed and/or current liabilities . This gives a percentage that represents the proportion of external financing that the company has in relation to its assets .
Different formulas can be used to calculate it, since the net worth can be related to the company's total liabilities , or to the short- or long-term liabilities.
If the ratio is greater than one, it means that debts exceed equity. This situation can be worrying in certain companies if it is greater than one.
In any case, the result of this ratio cannot be analysed on its own. The economic situation and the sector in which the company operates are also important. For example:
In some sectors, such as construction, companies may have high levels of debt while carrying out their promotions and being fully viable.
In relation to the economic situation, if it is not good, financial institutions and suppliers will be more reluctant to grant financing and will demand greater contributions from shareholders.
If the result were equal to one, it would mean that the company's financing is divided equally between the company's creditors and shareholders.
That is, if the company's creditors, which usually include financial institutions, observe that the ratio significantly exceeds one, they may stop financing the company. They may interpret this as a sign that their partners are not betting on the company and are looking for the majority of the financial risk to fall on financial institutions and other creditors.
This ratio is therefore also used to measure the company's dependence on external financing .
It is important to include your business's debt ratio in your dashboard . But if your accounting software calculates it automatically, you will always have it available and managing your business will be much simpler.
We explain what the debt ratio is and the different types of debt ratios that you can use.
Learn in this article how to interpret it and its formula to calculate it.
Excessive debt is one of the main reasons why many companies end up closing their doors. To know when debt levels start to become alarming, the debt ratio is used.
Start of marked textSHARE! What is a cyprus email list company's debt ratio? How is it interpreted and calculated? Find out in this post.End of marked text
This ratio is often used together with other financial indicators to perform a complete analysis of the financial statements in a given period. This analysis will allow a financial diagnosis of the company to be made, which will allow us to know, among other things:
The financial strengths and weaknesses of the company.
Your level of debt.
Compare the company's situation with other periods or companies in the sector.
The debt ratio is usually transferred together with the main financial indicators to a dashboard for easy consultation by company managers.
Companies that are most concerned about maintaining control of their business at all times use applications that generate dashboards with the main ratios in an automated manner .
Download the FREE guide “The art of getting paid (on time)”
1) What is the debt ratio?
The debt ratio is a financial indicator that allows us to know the proportion of debt that a company has in relation to the assets it has .
Thanks to this ratio, you can determine your dependence on external financing and whether your business is excessively indebted.
Debt is recorded as a liability on the balance sheet and refers to all payments that a company must make in the long and short term.
The debt ratio is an indicator of the company's financial structure, as it relates its own and external resources.
2) What is the debt ratio formula?
To calculate the debt ratio, the net value of the company's equity must be related to the fixed and/or current liabilities . This gives a percentage that represents the proportion of external financing that the company has in relation to its assets .
Different formulas can be used to calculate it, since the net worth can be related to the company's total liabilities , or to the short- or long-term liabilities.
If the ratio is greater than one, it means that debts exceed equity. This situation can be worrying in certain companies if it is greater than one.
In any case, the result of this ratio cannot be analysed on its own. The economic situation and the sector in which the company operates are also important. For example:
In some sectors, such as construction, companies may have high levels of debt while carrying out their promotions and being fully viable.
In relation to the economic situation, if it is not good, financial institutions and suppliers will be more reluctant to grant financing and will demand greater contributions from shareholders.
If the result were equal to one, it would mean that the company's financing is divided equally between the company's creditors and shareholders.
That is, if the company's creditors, which usually include financial institutions, observe that the ratio significantly exceeds one, they may stop financing the company. They may interpret this as a sign that their partners are not betting on the company and are looking for the majority of the financial risk to fall on financial institutions and other creditors.
This ratio is therefore also used to measure the company's dependence on external financing .
It is important to include your business's debt ratio in your dashboard . But if your accounting software calculates it automatically, you will always have it available and managing your business will be much simpler.