A debt ratio does not necessarily indicate whether a company is financially healthy or not, it just one of the indicators used to assess a company’s financial leverage. Other financial ratios and financial statements should be considered when evaluating a company’s overall financial health and performance. The long-term debt ratio is a measure of income summary a company’s ability to meet its long-term financial obligations.

Understanding the Debt Ratio: Definition and Formula
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For example, Microsoft Excel provides a balance sheet template that automatically calculates financial ratios such as the D/E ratio and the debt ratio. For instance, capital-intensive companies with stable cash flows operate successfully with a much higher debt ratios. South Africa, renowned for its abundant natural resources and well-developed financial and communication sectors, provides an intriguing case for examining debt ratios across diverse industries. Likewise, the telecommunications a debt ratio of 0.5 indicates: sector, another prominent player, has witnessed an increase in debt ratios due to the capital-intensive nature of expanding and modernizing infrastructure.
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The risk from leverage is identical on the surface but the second company is riskier in reality. The obvious limitation of a debt ratio is that it does not provide any indication of asset quality because it uses all types of assets and liabilities combined together. In the unique economic landscape of South Africa, the debt ratio assumes a heightened significance due to various factors.
Practical Application: Using Debt Ratio in Investment Decisions

Conversely, during periods of economic growth, a high debt ratio may not necessarily be a red flag. In a bullish market, companies often borrow to fund expansion plans and business growth. If a company can generate a good rate of return from the borrowed funds, a higher debt ratio can actually be a sign of aggressive growth strategy. Investors may view it as an aggressive use of leverage to increase the potential rate of return for equity shareholders.
- Since this is less than 1, this is considered a low-risk debt ratio and you may go for that much longed-holiday or even seek financial assistance from a bank to pay for your vacation.
- A comfortable debt-to-income ratio is generally considered to be around 36% or lower, although this may vary depending on your individual circumstances.
- Other factors such as an organization’s policy on CSR, its current operational needs, and the expected returns on CSR investments also play a significant role.
- A debt ratio of 0.75 suggests a high level of financial leverage and requires careful monitoring of cash flows and debt management.
- Understanding how to calculate debt ratio is fundamental for assessing a company’s financial health and stability.
- The debt-to-equity ratio, for example, is closely related to and more common than the debt ratio, but it uses total liabilities as the numerator.
However, in most cases, a current ratio between 1.5 and 3 is considered acceptable. By contrast, a current ratio of less than 1 may indicate that your business has liquidity problems and may not be financially stable. When it comes to managing your finances, it’s essential to keep a balance between debt and other financial goals. While it’s important to pay off your debts, you also need to ensure that you’re not compromising on other essential financial goals such as saving for emergencies, retirement, or other long-term goals. Striking the right balance between debt repayment and other financial goals can be challenging, but it’s not impossible. With a bit of planning and discipline, you can achieve your financial goals while paying off your debts.
- Lenders often take the debt ratio into account when assessing creditworthiness.
- Yet, it is pivotal to be cautious and evaluate the debt ratio in the overall context of a company’s financial picture and sector norms.
- Is your small business based in New York and in need of financial assistance?
- A particularly low D/E ratio might be a negative sign, suggesting that the company isn’t taking advantage of debt financing and its tax advantages.
- On the other hand, a low debt ratio, typically below 0.3 or 30%, suggests a company primarily uses equity to finance its operations.
Financial ratios software offers robust analytical capabilities for calculating, analyzing, and interpreting debt ratios, along with other key https://www.bookstime.com/ financial metrics. Common debt ratios include debt-to-equity, debt-to-assets, long-term debt-to-assets, and leverage and gearing ratios. Perhaps 53.6% isn’t that bad when you consider that the industry average was 79% in 2022.
- As of the end of 2018, its debt-to-equity (D/E) ratio was 1.63%, which is lower than the industry average.
- Used in conjunction with other measures of financial health, the debt ratio can help investors determine a company’s risk level.
- Now, the question of whether this company is in a better financial situation than a company with a debt to asset ratio of 0.4 or 40% will depend on the industry.
- The debt ratio interpretation is used by investors and analysts to determine how much risk a company has acquired.
- A high debt ratio might provide more resources for growth and expansion, but it also brings potential financial risk if the borrowing company struggles to repay the debt.
- These balance sheet categories may include items that wouldn’t normally be considered debt or equity in the traditional sense of a loan or an asset.
The debt-to-equity ratio is most useful when it’s used to compare direct competitors. A company’s stock could be more risky if its D/E ratio significantly exceeds those of others in its industry. Gearing ratios focus more heavily on the concept of leverage than other ratios used in accounting or investment analysis. The underlying principle generally assumes that some leverage is good, but too much places an organization at risk.
The debt ratio is an important financial metric that is used by investors, creditors, and analysts to evaluate a company’s financial health. A high debt ratio can indicate that a company is taking on too much debt and may have difficulty meeting its debt obligations. On the other hand, a low debt ratio can indicate that a company has a strong financial position and is less risky for investors and creditors. The debt ratio is calculated by dividing the total debt by the total assets or income.