The Debt Ratio is basically the total assets in a business that was acquired by the business borrowing the money from financial institutions and other such creditors to purchase those assets. The basic formula is Debt Ratio = (“Total Liabilities“/”Total Assets“) Let’s break this down into a real world example:
Let’s pretend that you are a newspaper boy (or girl), and you’re figure that you can take an additional route that could make you more money if you were to buy a bicycle with a basket. Such a bike and basket would cost you a cool $200 dollars. But unfortunately you only have $50.
So what you decided to do is hit a creditor (good old dad, but it could be a bank, etc…), up for the $150 needed to complete the purchase of the $200 dollar asset aka the bike ($150 borrowed + $50 your money).
Based on our formula, we plug in the numbers into the formula above (150/200) = .75 so if you take your fraction times 100, we find that 75% of our asset is via borrowed money that we owe creditors (dad or the bank, etc).
With large businesses, many time debt is a great tool that helps a business expand and prosper… to a point! If the debt ratio is too high (especially with respect to stocks), this may indicate problems with the company. Sometimes a very large debt number may indicate that the interest on the debt payment may be eating all of the company’s profits! Well, they you have it, Debt Ratio defined