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Finance

What is Involved in Calculating Debt Ratios?

By C. Daw
Updated May 17, 2024
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The steps that are involved in calculating debt ratios are to place specific aspects of the operating costs and incomes into a mathematical formula to come up with a percentage that reflects the overall debt of the company. These numbers are taken from specific areas on the accounting forms and placed into the formula in a specific order. The basic mathematical formula used in calculating debt ratios is the total debts divided by the total assets, or to use the second formula that is the total liabilities divided by the total assets. The number that is calculated is the total debt ratio of the company, which is used by investors and lenders to decide whether the company is a high or low risk. The lower the debt ratio is, the lower the risk is for the investor or lender.

The first number that has to be placed into the mathematical formula when calculating debt ratios is the total debt or total liabilities. This number can be calculated by the company accountant, or better yet, taken from the balance sheets that are produced on a quarterly basis. This number signifies the total amount of long and short term debts that the company has, including daily operating expenses such as payroll and utilities. This debt total will also include loans or tax payments that are due, as well as any large purchases or loans that have been acquired.

When calculating debt ratios, the second number that has to be considered is the total amount of assets that the company has. This number is also obtained from the balance sheets or through the accountant. This number will include liquid assets, as well as current and fixed assets. This means that all of the income, along with the value of property and equipment, and any other income received from other sources, will be added together to get the total assets.

It is an easy process to calculate the percentage as long as the records of the company are accurate and easy to obtain. Most of the time, calculating debt ratios will be accomplished by using the most current financial statements from the company, but in some instances the investor or lender will demand an updated percentage. When this happens, a new set of financial statements will be calculated and printed, giving the most up-to-date numbers available to complete an accurate debt ratio for them. The debt ratio is basically a mathematical equation that divides the debts by the assets in order to obtain a percentage that reflects how much debt the company is in.

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