The debt ratio is a measure that shows what portion of a company’s assets is financed with debt. It provides insight into how dependent a business is on borrowed money. The higher the debt ratio, the larger the share of debt within the total financing.
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The debt ratio helps to assess the financial stability of a company.
The debt ratio is usually calculated by dividing total debt by total assets. A high ratio means that a large portion of the assets is financed with borrowed capital. This can be beneficial when a company is growing profitably, but it increases risk when revenues decline.
A low debt ratio indicates less dependence on creditors and often more financial flexibility. What is considered healthy differs by sector and type of company.
Short example:
Suppose a company has €2,000,000 in assets and €1,000,000 in debt. The debt ratio is then €1,000,000 divided by €2,000,000, or 50%.
If another company has €1,600,000 in debt with the same assets of €2,000,000, the debt ratio is 80%. This company is financed to a greater extent with borrowed money and is more sensitive to financial headwinds.
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