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What Is the Debt Ratio?
The debt ratio tells you how much of your business is funded by debt instead of your own money or equity. It’s one of the most basic ways to measure financial risk. A higher debt ratio means you’re more reliant on borrowed money. A lower one means you own more of your company’s assets outright.
Why Debt Ratio Matters for Your Business
This ratio helps you understand your company’s financial leverage. Whether you’re applying for a loan or reviewing a weekly management report that must include debt ratio figures, it tells you how exposed your business is to debt obligations.
Lenders use it to gauge creditworthiness and to determine the interest rate they’ll offer. Investors use it to assess risk. Business owners use it to make better decisions around borrowing, debt financing, and sustainable growth.
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Debt Ratio Formula (With Easy Examples)
The debt ratio is calculated by dividing your total liabilities by your total assets:
Debt Ratio = Total Liabilities ÷ Total Assets
Let’s break that down.
Say your business has:
- Total liabilities: $400,000 (including loans, unpaid bills, and credit cards)
- Total assets: $1,000,000 (including cash, inventory, equipment, and accounts receivable)
Then:
Debt Ratio = $400,000 ÷ $1,000,000 = 0.4 or 40%
That means 40% of your assets are financed with borrowed money. The rest is funded by equity or retained earnings.
Comparing Debt Ratio vs. Borrowing Ratio
People sometimes confuse the debt ratio with the borrowing ratio. While they both measure leverage, they look at different pieces of the puzzle.
The borrowing ratio is narrower. It leaves out short-term liabilities like credit cards or accounts payable.
Debt to Asset Ratio Analysis: What It Reveals
The debt to asset ratio is another name for the debt ratio, but it’s especially useful when tracking changes over time.
Looking at your ratio quarter over quarter tells you if you’re becoming more or less reliant on debt. This kind of analysis can help identify trends in your debt financing strategies.
Use it to:
- Monitor borrowing trends
- Track growth in assets vs. liabilities
- Benchmark against competitors
Other Ratios to Track: Debt to Equity, Interest Coverage & More
To get the full picture, pair the debt ratio with other financial metrics:
- Debt to equity ratio: Measures leverage based on owner equity.
- Interest coverage ratio: Shows how easily you can cover interest expenses, which are directly affected by your average interest rate.
- Accounts payable turnover: Measures how fast you’re paying vendors.
- Cash flow to debt ratio: Links operational cash flow to liabilities.
- Total liabilities to assets: Similar to the debt ratio but includes all obligations.
Using multiple ratios helps you spot risks early and interpret the complete financial statement.
When to Worry: Signs of Financial Risk
A debt ratio above 0.6 is a signal to look closer. It could mean your company is heavily reliant on lenders. That might hurt your cash flow or raise red flags with banks, especially when interest rates rise.
At the same time, an ultra-low debt ratio could mean you’re missing out on smart growth through financing. Balance is key.
Watch out for:
- Spikes in total liabilities
- Declining equity
- Falling cash flow
All three can put your financial health at risk.
How to Improve Your Debt Ratio
If your debt ratio is too high, here’s what you can do:
- Reduce liabilities: Pay off loans or restructure debt.
- Increase assets: Invest profits back into the business to grow your company’s assets.
- Raise equity: Bring in new investors or retain earnings.
Focus on both sides of the equation. The goal is to improve the ratio without hurting operations.
Where It Shows Up in Weekly Reports
Your weekly management report should include a snapshot of the company’s financial metrics. The debt ratio belongs in the finance summary. Any good weekly management report should include debt ratio, especially if you’re tracking financial risk.
Example Block:
- Debt Ratio: 0.45
- Debt to Equity: 0.9
- Accounts Payable: $80,000
- Cash Flow: $60,000
Tracking this weekly helps you catch issues before they escalate.
Key Takeaways for Finance Teams
- The debt ratio measures how much of your business is funded by liabilities.
- It’s calculated by dividing total liabilities by total assets.
- Don’t ignore credit cards, accounts payable, or short-term loans—they all count.
- Pair it with other metrics like interest coverage and cash flow.
- Include it in your weekly management report and ensure it includes debt ratio for transparency.
- Watch how it reflects across your financial statement.
Final Thoughts
The debt ratio is a simple but powerful way to measure your business’s financial health. By tracking it regularly and pairing it with other metrics, you can make smarter decisions, manage risk, and stay ready for growth.
Don’t just file it away—use it.
Frequently Asked Questions
What is a good debt ratio?
Usually below 0.5. Anything higher might signal elevated risk depending on the industry.
How do I find total liabilities?
Check your balance sheet. It includes loans, credit cards, unpaid bills, and other obligations.
Do intangible assets count in the formula?
Yes, but some analysts exclude them for a more conservative estimate.
Does the debt ratio affect cash flow?
Indirectly. More debt often means higher interest costs, which can reduce free cash.
What about accounts receivable?
They count as assets and are part of the equation when calculating your ratio.
