Therefore, Company ABC has a Debt-to-EBITDA ratio of 2.5, meaning it has debt ratio formula $2.50 of debt for every $1.00 of EBITDA. In our example, BlueChip Tech Inc. has a lower Debt-to-Capital Ratio (0.25) than Stable Steel Corp. (0.40). This indicates that BlueChip Tech Inc. is less dependent on debt for its capital needs than Stable Steel Corp. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts.

What the Total Debt-to-Total Assets Ratio Can Tell You

Debt reduction techniques focus on lowering overall debt levels to improve debt ratios and enhance financial flexibility. The interest coverage ratio evaluates a company’s ability to meet its interest obligations on outstanding debt. It measures the company’s ability to generate earnings sufficient to cover interest expenses. The trend analysis of historical performance will show how the company has acquired and grown its assets and How to Run Payroll for Restaurants how its financial risk profile is evolving.

• Contrarily, if the company’s assets yield low returns, a low debt ratio does not automatically translate into profitability.
• Higher debt as a percentage of total capital means a company has a higher risk of insolvency.
• This is because it is dependent on creditors to finance its operations and may end up paying very high amount of interests on loan that will erode its profits.
• Whether this is “good” varies based on industry benchmarks and the company’s specific circumstances.
• A high debt ratio indicates that a company is highly leveraged, and may have borrowed more money than it can easily pay back.
• Depending on averages for the industry, there could be a higher risk of investing in that company compared to another.

Step 1. Capital Structure Assumptions

However, an excessive debt may restrict a company’s operational flexibility and result in higher funding costs. Strategic decisions hinge on maintaining an optimal balance between debt and equity financing to support the company’s objectives while managing its financial health. Debt-to-equity measures how much debt a company has to its shareholders’ equity. Because shareholders’ equity is part of total liabilities, it shows how much of a business’s debt is equity financing. Lower ratios are ideal, but “good” depends on a business’s financial structure and contra asset account how other companies in the same industry structure themselves.

Financial health assessment

Therefore, we can say that 41.67% of the total assets of ABC Ltd are being funded by debt. Outside the context of a sale, net debt provides an indicator of the company’s solvency. The money that the bank provides is called principal because it’s the driving value of the loan that determines its interest obligations.

Higher ratios suggest over-leverage and financial risk, as the company relies more on borrowed funds. In other words, the ratio does not capture the company’s entire set of cash “obligations” that are owed to external stakeholders – it only captures funded debt. The debt to asset ratio analysis is typically used by investors, analysts, and creditors to assess a company’s overall risk. Hence, it is considered a risky investment, and the banker might reject the loan request of such an entity. Further, if the ratio of a company increases steadily, it could indicate that a default is imminent at some point in the future.