Debt to Asset Ratio
When there are more debts than assets, that means creditors have a larger stake than its shareholders.
How to use debt to asset ratio
- Lower is better.
- below 1 (100%) is considered healthy but always compare the company to industry mean.
- Can be very different between industries.
- Can be used to compare companies.
Why do investors use the debt to asset ratio in their analysis
It shows how much debt the company used to finance its assets. If a company is almost entirely financed with debt that means the company might get into serious trouble when emergencies arise like a raise in interest.
The three steps every investor should look at:
- What is the current debt to asset ratio?
- How does it compare to the industry?
- What is the trend?
Things to be aware of
- Only compare with other companies in the same industry
- Some companies can have higher debt to assets ratio's (for example, banks).
- Debt to asset ratio should improve over the years.
- If the debt to asset ratio is above 1, look at the industry mean and find out why the company has so much debt.
How to calculate debt to asset ratio
Real life example
A real life example of Tesla. You need the following data to determine debt to asset ratio:
- Debt to asset ratio = total debt \ total assets
- $30,855,000 \ $68,513,000 = 0.45
The debt to total assets ratio shows if the company is owned by creditors or shareholders. Or in other words, the total debt in relation to the total amount of assets. It shows how much debt the company used to finance its assets.
If the ratio is 0,6, that means that 60% is financed by creditors and 40% is financed by its owners (shareholders). In this case, a higher ratio means more risk because most of the company is financed by creditors. A ratio above 1 means the company is funded by credit and took on many loans.
How you think about this?