Debt Ratio

Topics: Asset, Balance sheet, Liability Pages: 1 (385 words) Published: October 25, 2014

ACC111- LESSON 2

There are many tools that a company can use to evaluate how well it is performing, one of those tools is the debt ratio calculation. The debt ratio shows the proportion of assets financed with debt, liabilities. It is calculated by the companies total liabilities divided by its total assets and is used as a percentage. Total assets and total debts can be found on the balance sheet. “It can be used to evaluate a business’s ability to pay its debt” (Nobles p. 89).

The debt ratio can be used to evaluate a business’s ability to pay it’s debts. An investor will want to know what percentage a business is at because it helps determine a company's risk level. The higher the debt ratio, the higher the risk. “Companies that have a high percentage of liabilities are at greater risk of default. If they are unable to pay their creditors as the amounts become due, the creditors have the right to claim the assets” (Nobles p. 90). As the ratio number moves closer to 1, more of a company’s assets are then being financed by debt therefore more likely moving closer to bankruptcy. The debt ratio is not just a good or bad number, “high” and “low” ratios vary by industry. “Debt ratios vary widely across industries, with capital-intensive businesses such as utilities and pipelines having much higher debt ratios than other industries like technology” (“DEFINITION of 'Debt Ratio’”, 2014).

The debt ratio is a tool that is used to determine if a company is a good investment to make and how well it is performing. The debt percentage is found by taking a companys total liabilities, or debt, and dividing it by the total assets. The percentage alone, whether it being high or low, does not determine if a company is a good or bad risk. An investor must be familiar with what that industry average is to make an educated decision.

Works Cited:

Nobles, Tracie, Brenda Matisn, and Ella Mae Matsumura. "Accounting and the Business...


Cited: Nobles, Tracie, Brenda Matisn, and Ella Mae Matsumura. "Accounting and the Business Environment." Horngre 's Accounting. Tenth ed. Upper Saddle River: Pearson Learning Solutions, 2014. Print.
na. "Debt Ratio Definition." Investopedia. Investopedia, 17 Mar. 2014. Web. 23 Oct. 2014.
DESCRIBE HOW TO CALCULATE DEBT RATIO AND EXPLAIN IT’S PURPOSE AND WHAT IT EVALUATES.
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