Total debt to total assets is a leverage ratio that defines how much debt a company owns compared to its assets. Using this metric, analysts can compare one company’s leverage with that of other companies in the same industry. This information can reflect how financially stable a company is. The higher the ratio, the higher the degree of leverage and, consequently, the higher the risk of investing in that company.
The total debt to total assets ratio analyses a company’s balance sheet. The calculation includes long-term and short-term debt (borrowings maturing within one year) of the company. It also encompasses all assets—both tangible and intangible. It indicates how much debt is used to carry a firm’s assets, and how those assets might be used to service debt. Furthermore, it, measures a firm’s degree of leverage.
Debt servicing payments must be made under all circumstances, otherwise, the company would breach its debt covenants and run the risk of being forced into bankruptcy by creditors. While other liabilities such as accounts payable and long-term leases can be negotiated to some extent, there is very little manoeuvring room with debt covenants.
Equation: Total Debt to Total Assets = (Short-Term Debt + Long-Term Debt) / Total Assets
If the calculation yields a result greater than 100%, this means the company is insolvent, as it has more liabilities than all of its assets combined. In general, the total debt to total assets ratio should be less than 100%. A result of 50% means that 50% of the company’s assets are financed using debt (with the other 50% being financed through equity).
Total-debt-to-total-assets is a measure of the company’s assets that are financed by debt rather than equity. When calculated over a number of years, this leverage ratio shows how a company has grown and acquired its assets as a function of time.
Investors use the ratio to evaluate whether the company has enough funds to meet its current debt obligations and to assess whether the company can pay a return on its investment. Creditors use the ratio to see how much debt the company already has and whether the company can repay its existing debt. This will determine whether additional loans will be extended to the firm.
A ratio greater than 100% shows that a considerable portion of the assets is funded by debt. In other words, the company has more liabilities than assets. A high ratio also indicates that a company may be putting itself at risk of defaulting on its loans if interest rates were to rise suddenly.
A ratio below 50%, meanwhile, indicates that a greater portion of a company’s assets is funded by equity. This often gives a company more flexibility, as companies can increase, decrease, pause, or cancel future dividend plans to shareholders. Alternatively, once locked into debt obligations, a company is often legally bound to that agreement.
Global average standard ration is between 30% to 60%
Source: Investopedia
