WHAT ARE DEBT RATIOS? - DUDAS - 2025

The debt ratios are indicators that measure the development in a company uses debt to finance its operations, and the ability of the entity to pay that debt. There are different debt ratios, thus giving analysts a global notion of the entity's overall debt load, as well as its combination of debt and equity.

These reasons are important to investors, whose equity investments in a company could be put at risk if the level of debt is too high. Lenders are also avid users of these reasons, to determine to what extent borrowed funds could be at risk.

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In general, the greater the amount of debt a business owns, the greater the level of potential financial risk the business could face, including bankruptcy.

Debt is a way that a company has to leverage itself financially. The more leveraged a company is, the greater amount of financial risk it will have. However, a certain level of indebtedness can contribute to the progress of the company.

Debt to asset ratio

This meter compares all of a company's debt to its total assets. This gives investors and creditors a general idea of ​​the amount of debt an organization uses.

When the percentage is lower, a company is using less debt and its capital position is stronger. In general, the higher the ratio, the greater the risk the company is considered to have assumed.

The debt to assets ratio is calculated as follows: total liabilities divided by total assets.

If a company has $ 1 million in total liabilities compared to $ 3 million in total assets, this means that for every dollar the company has in assets, it will have 33 cents of liability.

Debt to equity ratio

Compare the total liabilities of a company with the total equity of its shareholders.

This ratio provides another point of view on the debt position of a company, when comparing total liabilities with shareholders' equity, rather than with total assets.

A lower percentage means that a company is using less debt and has a stronger capital position.

The ratio is calculated by dividing the total liabilities of the company by the equity of its shareholders.

Like the debt-to-assets ratio, this ratio does not fully measure the debt of a company, because it includes operating liabilities as part of total liabilities.

Result by industry

What constitutes a good or bad debt outcome will vary by industry. For example, an industry such as telecommunications requires a significant capital investment.

These expenses are often financed through loans, so all other things being equal, the debt-to-equity ratio would be on the high side.

The banking industry is another area with typically high levels of debt to equity. Banks use the borrowed money to make loans at higher interest rates than they pay on the funds they borrow. This is one of the ways they make a profit.

The actual use of the debt to equity ratio is in comparing the ratio for companies in the same industry. If a company's debt-to-equity ratio varies significantly from its competitors or its industry averages, this should raise a red flag.

Capitalization ratio

It measures the debt component within the capital structure of a company, which is defined as the combination of debt liabilities and shareholders' equity on the company's balance sheet.

Debt and equity are the two means that a company can use to finance its operations and any other capital expenditure.

This ratio is calculated by dividing the debt liabilities of the company by the debt liabilities plus the equity of the shareholders.

The capitalization ratio is one of the most significant indebtedness ratios, because it focuses on the ratio of debt liabilities as a component of a company's total capital base, which is collected from shareholders and lenders.

Debt vs. heritage

Debt has some advantages. Interest payments are tax deductible. The debt also does not dilute the ownership of the company, as does the issuance of additional shares. When interest rates are low, access to debt markets is easy and money is available to lend.

The debt can be long or short term and can consist of bank loans issued by bonds.

Equity can be more expensive than debt. An additional capital increase by issuing more shares can dilute the ownership of the company. On the other hand, the capital does not have to be paid back.

A company with too much debt may find that its freedom of action is restricted by its creditors and / or its profitability may be affected by high interest charges.

Interest coverage ratio

It is used to determine how easily a business can pay its interest expense on outstanding debt.

The ratio is calculated by dividing the company's profitability before interest and taxes by the company's interest expense for the same period.

The lower the ratio, the more burden the company will have for debt expenses. When a company's interest coverage ratio is only 1.5 or less, its ability to cover interest expenses may be questionable.

The ratio measures how many times a business could pay its outstanding debts using its profit. This can be considered as a margin of safety for the creditors of the company, in case it has financial difficulties in the future.

Determine solvency

The ability to meet debt obligations is a key factor in determining a company's creditworthiness, and is an important statistic for potential shareholders and investors.

Investors want to be sure that a company they are considering investing in can pay its bills, including interest expenses. They do not want the growth of the company to be affected by these types of financial problems.

Creditors are also concerned about the company's ability to pay its interest. If you are having difficulty making interest payments on your debt obligations, it doesn't make any sense for a potential lender to extend additional credit.

References

1. Investopedia (2017). Debt Ratios. Taken from: investopedia.com.
2. Steven Bragg (2018). Debt ratios. Accounting Tools. Taken from: accountingtools.com.
3. CFI (2019). Leverage Ratios. Taken from: corporatefinanceinstitute.com.
4. Money-Zine (2019). Debt Ratios (Leverage Ratios). Taken from: money-zine.com
5. AAII (2010). Analyzing Debt Ratios. Taken from: aaii.com.