Accounting: Debt Ratio

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When banks consider lending money to a business, they need to have confidence that they will be repaid. One of the main metrics they look at is the debt ratio, which is the proportion of assets financed by debt. The debt ratio is calculated by dividing total liabilities by total assets.


Essentially, the debt ratio indicates the ability of the business to pay its debts, and thereby indicates how risky it would be to lend the business money. If the assets of the business are primarily backed by debt (that is, if the debt ratio is high), then the risk of default is greater. If the assets of the business are backed by equity instead (meaning that the debt ratio is low), then the business is a more reassuring debtor.


As with all financial ratios, the debt ratio must be considered in context. A diligent financial analyst would want to know how the debt ratio of a business has changed, and would want to make comparisons to other businesses in the same industry. Debt ratio is an important measure, but it is just one among many that an accountant, analyst, or shareholder will consider when appraising financial statements.