While a low debt ratio is good in the sense that the company’s assets are enough to meet its obligations. It may indicate underutilisation of a major source of finance which may result in restricted growth. A very high ratio indicates high risk for both debt-holders and equity investors. Due to the high risk, the company may not be able to obtain finance at good terms or may not be able to raise any more money at all.
The compares a company’s total debt to its total assets. This provides creditors and investors with a general idea as to the amount of leverage being used by a company. The lower the percentage, the less leverage a company is using and the stronger its equity position
Less than 0.2
Debt Ratio = Total Debt / Total Assets
It finds out the percentage of total assets that are financed by debt and helps in assessing whether it is sustainable or not. If the percentage is too high, it might indicate that it is too difficult for the business to pay off its debts and continue operations. Since not being able to pay off debts and interest payments may result in a business being wound up, it is a critical indicator of long-term financial sustainability of a business.
Businesses set their target debt ratio based on their target capital structure. It involves trade-off between the financial risk and growth.
It is very industry-specific ratio and should be analysed in comparison with competitors and together with other ratios.
It goes without saying you need to keep your debt ratio below the target. It’s not always that easy but maintaining a result close, if not under, by managing debtors, is a key action to help you not just survive, but thrive.
I encourage you to create a report or a dashboard that gives you all your figures whenever you need them. If you don’t have the time or resources to make that happen then sign up for Blue Bean today and you’ll see your metrics within a few minutes.
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