The total debt to total asset ratio — also known as the debt to total assets ratio — is a risk measurement calculation used to determine what portion of assets the company financed with debt. In its basic form, the ratio is quite broad, as it includes both short- and long-term debt divided by all assets, intangible and tangible. It is a common measurement calculated by stakeholders within the firm and those outside of the company. Firms with a high degree of debt leverage compared to assets are seen as more risky than those companies with less debt.
To calculate the total debt to total asset ratio, information from a company’s balance sheet is necessary. This financial statement provides a snapshot of the company’s economic wealth at a specific point in time. If a company has total assets of $1,250,000 US Dollars (USD) and $1,500,000 USD in total debt for the year ending December 2010, the company’s total asset to total debt ratio is $.83 USD. Another way to put this statement is for every $1 USD in assets, the company has $.83 USD in debt. If the company were to fail and need to liquidate its assets to pay off creditors, more than three quarters of the company’s assets would go to pay off the debt.
In order to lower the total debt to total asset ratio, a company will need to find another way to purchase assets. Other options include paying for assets with capital generated from normal business operations, securing private equity investments from private inventors or issuing stock. While the first option is typically the safest, albeit harder to accomplish, the latter two options are still preferable compared to using debt. A significant bonus for using equity to finance business operations comes from equity holders having limited representation during a business liquidation process. For example, if a company has $750,000 USD in debt and $500,000 USD in equity, creditors owed the $750,000 USD will receive first payments from liquidated assets. Investors holding the $500,000 USD in equity may receive nothing if no capital remains from liquidation.
A disadvantage to this ratio is that it does not indicate how the company plans to use the borrowed funds. Users of the total debt to total asset ratio will need to determine if the firm is purchasing short-term or long-term assets. Using borrowed capital for short-term assets can be a sign of money trouble within the company. Long-term assets should help the company increase its economic wealth through additional sales and higher capital generation from produced goods and services.
