To find the answer to this question, leverage ratios will come in handy, as they offer valuable information about your company and:
- the ability to cover its interests
- the way in which the assets are financed: if it’s rather through internal resources (shareholders equity) or external resources (loans)
- the ability to meet its debt obligations
- the percentage of its assets provided through debt
Debt Ratio
In this article, we will focus on debt ratio, but if you need to find out more about interest cover ratio, debt to equity ratio (D/E), or solvency ratio, download our free ebook containing the most important information you should know about financial ratios as an entrepreneur.
The debt ratio is an indicator measuring the percentage of a company’s assets provided through debt.
This indicator will tell you how much debt you have for each 1$ stored in assets. Debt ratio is a percentage and is obtained by using the formula:
Debt ratio = (Total Debts/ Total Assets) * 100
If your debt ratio is 80%, this means that for each $1 owned, you owe 80 cents. A company with a debt ratio higher than 100% has more debts than assets, therefore a lower value is usually recommended.
However, there are a lot of companies that grow based on debts because they find an efficient way to use the money and generate even more out of daily operations.
In order to gain more data on how you use and return the money you borrow, correlate debt ratio with profitability or liquidity ratios. For example, even though you have a high debt ratio, if your ROA is also increasing, then it means that you are using money efficiently and generate profit out of it – so you get the most out of your loan.
Also, if your debt ratio is high, but your current ratio is higher than 1, then you can survive without problems. Be careful with your cash flow though.
Find all leverage ratios, explained in an easy-to-understand language, in our last free ebook, Top financial indicators every entrepreneur should know. We put everything together there, profitability ratios, liquidity ratios, efficiency ratios, with real-life examples and recommendations. Happy reading!
FAQs
In general, many investors look for a company to have a debt ratio between 0.3 and 0.6. From a pure risk perspective, debt ratios of 0.4 or lower are considered better, while a debt ratio of 0.6 or higher makes it more difficult to borrow money.
What is an acceptable amount of debt for a company? ›
Ideally, you want a debt-to-income ratio to hover at 36% or lower. If it's a little higher, that's okay; just keep it below 50%. At this range, your debt is more manageable. You will have more arsenal in the tank when it comes to negotiating your interest rate on future business loans.
What amount of debt is too much? ›
Generally speaking, a good debt-to-income ratio is anything less than or equal to 36%. Meanwhile, any ratio above 43% is considered too high. The biggest piece of your DTI ratio pie is bound to be your monthly mortgage payment.
How much debt do you think is too much? ›
Generally, 36% is considered a good debt-to-income ratio and a manageable level of debt, as no more than 36% of your gross monthly income goes toward debt payments.
How much debt is normal? ›
Average debt by credit score range
| Credit score range (FICO) | Total average debt (2023) | Total average debt (2022) |
|---|
| 300-579 (Poor) | $43,584 | $36,159 |
| 580-669 (Fair) | $68,020 | $65,362 |
| 670-739 (Good) | $94,836 | $95,067 |
| 740-799 (Very good) | $108,043 | $109,904 |
1 more rowMar 28, 2024
The optimal D/E ratio varies by industry, but it should not be above a level of 2.0. A D/E ratio of 2 indicates the company derives two-thirds of its capital financing from debt and one-third from shareholder equity.
What is the 50 30 20 rule? ›
The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings.
What is the 28 36 rule? ›
According to the 28/36 rule, you should spend no more than 28% of your gross monthly income on housing and no more than 36% on all debts. Housing costs can include: Your monthly mortgage payment.
What is unmanageable debt? ›
Personal debt can be considered to be unmanageable when the level of required repayments cannot be met through normal income streams. This would usually occur over a sustained period of time, causing overall debt levels to increase to a level beyond which somebody is able to pay.
What is the 20 10 rule? ›
However, one of the most important benefits of this rule is that you can keep more of your income and save. The 20/10 rule follows the logic that no more than 20% of your annual net income should be spent on consumer debt and no more than 10% of your monthly net income should be used to pay debt repayments.
Your debt-to-income (DTI) ratio is how much money you earn versus what you spend. It's calculated by dividing your monthly debts by your gross monthly income. Generally, it's a good idea to keep your DTI ratio below 43%, though 35% or less is considered “good.”
Is 1000 dollars a lot of debt? ›
A $1,000 balance isn't ideal -- but it's also not a deal-breaker. As a general rule, it's a good idea to steer clear of credit card debt, whether it's a $20 balance or a $20,000 balance. Of course, a $20 balance isn't going to cause you so much financial harm, while a $20,000 balance could drive you into bankruptcy.
Is 75% a good debt ratio? ›
A debt ratio below 0.5 is typically considered good, as it signifies that debt represents less than half of total assets. A debt ratio of 0.75 suggests a relatively high level of financial leverage, with debt constituting 75% of total assets.
Is a debt ratio of 75% bad? ›
Interpreting the Debt Ratio
If the ratio is over 1, a company has more debt than assets. If the ratio is below 1, the company has more assets than debt. Broadly speaking, ratios of 60% (0.6) or more are considered high, while ratios of 40% (0.4) or less are considered low.
Is 20k in debt a lot? ›
“That's because the best balance transfer and personal loan terms are reserved for people with strong credit scores. $20,000 is a lot of credit card debt and it sounds like you're having trouble making progress,” says Rossman.
Is 30% debt ratio good? ›
A debt ratio between 30% and 36% is also considered good. It's when you're approaching 40% that you have to be very, very vigilant. With a threshold like that, you're a greater risk to lenders. You may already be having trouble making your payments each month.
