What Is the Total Debt-to-Total Assets Ratio?
The debt ratio, or total debt-to-total assets, is calculated by dividing a company’s total debt by its total assets. It is also called the debt-to-assets ratio. It is a leverage ratio that defines how much debt a company carries compared to the value of the assets it owns.
Using this metric, analysts can compare one company’s leverage with that of other companies in the same industry. This information can reflect how financially stable a company is. The higher the ratio, the higher the degree of leverage (DoL). Depending on averages for the industry, there could be a higher risk of investing in that company compared to another.
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Understanding the Total Debt-to-Total Assets Ratio
The total debt-to-total assets ratio analyzes a company’s balance sheet. The calculation includes long-term and short-term debt (borrowings maturing within one year) of the company. It also encompasses all assets—both tangible and intangible.
It indicates how much debt is used to carry a firm’s assets, and how those assets might be used to service that debt. Therefore, it measures a firm’s degree of leverage.
Debt servicing payments must be made under all circumstances, otherwise, the company would breach its debt covenants and run the risk of being forced into bankruptcy by creditors. While other liabilities, such as accounts payable and long-term leases, can be negotiated to some extent, there is very little “wiggle room” with debt covenants.
A company with a high degree of leverage may thus find it more difficult to stay afloat during a recession than one with low leverage.
Total Debt-to-Total Assets Formula
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The total debt-to-total assets formula is the quotient of total debt divided by total assets. As shown below, total debt includes both short-term and long-term liabilities.
TD/TA = Short-Term Debt + Long-Term Debt Total Assets begin{aligned} &text{TD/TA} = frac{ text{Short-Term Debt} + text{Long-Term Debt} }{ text{Total Assets} } end{aligned} TD/TA=Total AssetsShort-Term Debt+Long-Term Debt
This calculation generally results in ratios of less than 1.0 (100%).
What Does the Total Debt-to-Total Assets Ratio Tell You?
Total debt-to-total assets is a measure of the company’s assets that are financed by debt rather than equity. If the calculation yields a result greater than 1, this means the company is technically insolvent as it has more liabilities than all of its assets combined. A result of 0.5 (or 50%) means that 50% of the company’s assets are financed using debt (with the other half being financed through equity).
Leverage Trends
When calculated over several years, this leverage ratio can show a company’s use of leverage as a function of time. For example, a ratio that drops 0.1% every year for ten years would show that as a company ages, it reduces its use of leverage.
Ability to Meet Debts
Investors use the ratio to evaluate whether the company has enough funds to meet its current debt obligations and to assess whether it can pay a return on its investment. Creditors use the ratio to see how much debt the company already has and whether the company can repay its existing debts. This will determine whether additional loans will be extended to the firm.
Real-World Example of the Total Debt-to-Total Assets Ratio
Let’s examine the total debt-to-total assets ratio for three companies:
- Alphabet, Inc. (Google), as of its fiscal quarter ending March 31, 2022.
- Costco Wholesale, as of its fiscal quarter ending May 8, 2022.
- Hertz Global Holdings, as of its fiscal quarter ending March 31, 2022.
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Here’s what each company’s ratio can tell you about it:
- Google is not weighed down by debt obligations and will likely be able to secure additional capital at potentially lower rates compared to the other two companies. Although its debt balance is more than three times higher than Costco, it carries proportionally less debt to total assets compared to the other two companies.
- Costco has been financed nearly evenly split between debt and equity. This means the company carries roughly the same amount of debt as it does in retained earnings, common stock, and net income.
- Hertz is known for carrying a high degree of debt on its balance sheet. Although its debt balance is smaller than the other two companies, almost 90% of all the assets it owns are financed. Hertz has the lowest degree of flexibility of these three companies as it has legal obligations to fulfill (whereas Google has flexibility regarding dividend distributions to shareholders).
It’s also important to understand the size, industry, and goals of each company to interpret their total debt-to-total assets. Google is no longer a technology start-up; it is an established company with proven revenue models that make it easier to attract investors. Meanwhile, Hertz is a much smaller company that may not be as enticing to shareholders. Hertz may find investor demands are too great to secure financing, turning to financial institutions for capital instead.
Limitations of the Total Debt-to-Total Assets Ratio
One shortcoming of the total debt-to-total assets ratio is that it does not provide any indication of asset quality since it lumps all tangible and intangible assets together.
For example, in the example above, Hertz reported $2.9 billion in intangible assets, $1.3 billion in PPE, and $1.04 billion in goodwill as part of its total $20.9 billion of assets. Therefore, the company had more debt ($18.2 billion) on its books than all of its $15.7 billion current assets (assets that can be quickly converted to cash).
Should all of its debts be called immediately by lenders, the company would be unable to pay all its debt, even if the total debt-to-total assets ratio indicates it might be able to.
As with all other ratios, the trend of the total debt-to-total assets ratio should be evaluated over time. This will help assess whether the company’s financial risk profile is improving or deteriorating. For example, a trend of increasing leverage use might indicate that a business is unwilling or unable to pay down its debt, which could signify issues in the future.
The Bottom Line
The total debt-to-total assets ratio compares the total amount of liabilities of a company to all of its assets. The ratio is used to measure how leveraged the company is, as higher ratios indicate more debt is used as opposed to equity capital. To gain the best insight into the total debt-to-total assets ratio, it’s often best to compare the findings of a single company over time or the ratios of similar companies in the same industry.
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