Assets to Liabilities Ratio | GOBankingRates
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The total-debt-to-total-assets ratio is one of many financial metrics used to measure a company’s performance. In this case, the ratio shows how much of a company’s operations are funded by debt. Other debt-related ratios include the debt-to-equity ratio, the current ratio, the interest coverage ratio, the debt-to-capital ratio and others.
The total-debt-to-total assets ratio is one of the most important because it shows how leveraged a company is and its potential risk of insolvency. Here’s a look at how to calculate and interpret the total-debt-total-assets ratio and how it can be used to make certain financial evaluations about a company.
How To Calculate Total Debt-To-Total Assets Ratio
The total-debt-to-total-assets ratio is straightforward. Simply divide a company’s total funded debt by its total assets. To express the ratio as a percentage, which is fairly common, multiply the result by 100.
As the name implies, a company’s “total debt” includes all of its obligations, both short-term and long-term. This includes everything from accounts payable and invoices owed to any bonds issued, credit card debt, short-term loans, long-term leases and so on.
Similarly, total assets include both current and non-current assets. This includes everything from cash and securities on hand to furniture, real estate, vehicles, inventory, intellectual property, patents, trademarks, licensing agreements, franchises, brand equity and more.
Valuing Assets and Liabilities
It can be quite difficult to value some of these assets and liabilities — or to even identify them in the first place. Therefore, most companies except the very smallest need to hire accountants. Once the tough task of identifying and quantifying assets and liabilities is complete, it’s actually easy to calculate a company’s total-debt-to-total-assets ratio.
Imagine, for example, that a company has $40 million in total liabilities and $100 million in total assets. You would then divide the $40 million in total liabilities by the $100 million in total assets. That will give the company a total-debt-to-total-assets ratio of 0.40, or 40% when multiplied by 100.
How To Interpret the Ratio
A high debt-to-assets ratio means that a company is financing a lot of its growth with debt. To some degree, this can be an effective strategy.
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By leveraging its financial position, a company with predictable cash flow can improve its financial return by using less of its own capital. Even in highly leveraged industries, though, there comes a point where debt becomes too much of a good thing. If it costs too much money to service the debt, a company that’s too highly leveraged runs the risk of insolvency.
That being said, in some industries, it makes more sense to have a higher debt-to-assets ratio, while in others, even low levels of debt can be problematic. If companies are in the business of making loans, for example, by definition they will have high debt-to-asset ratios. The same is true for companies that need to spend a lot on infrastructure to generate revenue.
What Is a Good Debt-to-Assets Ratio?
There’s no such thing as a good debt-to-assets ratio in an absolute sense, only a relative one. In other words, some industries are by nature more highly leveraged or asset-poor, making their debt-to-asset ratios high. This doesn’t necessarily mean they are “bad” companies. In fact, a company with a high debt-to-assets ratio might still be performing quite well. Various factors, such as industry, company size and financial goals can all skew a debt-to-asset ratio and give an inaccurate view of some businesses to investors who don’t dig deeper.
In a general sense, a “good” debt-to-assets ratio is 0.4 or lower, as it means a company has a lot of flexibility in terms of its leverage. A ratio of 0.6 or higher can often signal potential trouble and prohibit a company from taking on excess debt. But again, this can vary dramatically from industry to industry and through various economic times. Here are some sample average debt-to-asset ratios by various industries:
- Communication services: 60.85%
- Industrials: 61.80%
- Basic materials: 52.25%
- Consumer cyclical: 76.85%
- Financial services: 118.26%
- Consumer defensive: 57.40%
- Healthcare: 44.56%
- Technology: 57.61%
- Energy: 57.52%
- Real estate: 35.38%
One of the obvious outliers in this list is the financial services industry. But as banks are in the business of lending out money, it only makes sense that they have very high debt-to-asset ratios in an absolute sense. Utilities and telecommunications firms also typically have high absolute debt ratios because they invest heavily in equipment.
Applications of the Total-Debt-to-Total Assets Ratio
Analysts and investors use the debt-to-assets ratio to determine how leveraged a company is. In and of itself, this isn’t necessarily good or bad, but it does form a basis of comparison with other companies in a specific industry. It also helps reveal how creditworthy a company may be, and how much access it may have to additional capital in the future. These can be important when determining if a company is worth an investment.
On the corporate level, the debt-to-assets ratio plays an important role in terms of balance sheets and financial statements. It tells company officers and managers how much of a business’s operations are financed by debt, and it’s a ratio that can be managed so that a company operates at maximum efficiency.
Limitations of the Debt-to-Assets Ratio
No single financial metric can prove the stability, solvency or current financial status of a company in its entirety. That’s why the total-debt-to-total-assets ratio should be seen as just a single tool, meant to be complemented by other calculations and analysis. For example, the debt-to-equity ratio and interest coverage ratios are supplemental ways to see how leveraged a company is.
Remember that a high debt-to-assets ratio isn’t necessarily a bad thing. In fact, for a company with stable cash flows, like a utility, a high debt-to-assets ratio can actually be preferable, because it means the company can earn more for every dollar of revenue.
It’s also important to note that a company’s debt-to-assets ratio is not always entirely its own responsibility. Macroeconomic factors can cause a company to temporarily take on more debt. The black swan event of the pandemic, for example, caused many solid companies to take on more debt just to continue their operations. Other times, internal, company-specific events may temporarily–or permanently–raise or lower a debt-to-assets ratio. This is why it’s important to analyze other factors as well to get a complete picture of a company’s financial situation.
Case Studies and Examples
To highlight the differences in debt-to-assets ratios among different industries and companies, here’s a look at three companies in the utilities and information technology sectors.
Utilities
- Pacific Gas & Electric (PCG): 0.43, or 43%
- Southern Company (S): 0.42, or 42%
- NextEra Energy (NEE): 1.39, or 139%
In this example, NextEra Energy has a much higher-than-average ratio for the utility industry. As noted above, however, this is only one piece of the puzzle when it comes to evaluating the company for investment.
Information Technology
- Apple (AAPL): 0.314, or 31.4%
- Microsoft (MSFT): 0.114, or 11.4%
- Tesla (TSLA): 0.025, or 2.5%
As compared with the utility industry, all of these information technology companies have low debt-to-assets ratios. There’s still a wide variation within this sector, though. Industry leader Apple, for example, has a very good ratio of 0.314, but Tesla has hardly any debt at all compared with its assets. Again, this doesn’t make one a better investment than the other in and of itself, but it is a tool investors can use to begin their analysis.
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