To determine the financial state of a company, analysts typically utilize several different ratios, including the debt-to-asset ratio. A company's debt-to-asset ratio indicates the amount of assets it would have remaining after repaying all of its liabilities. Financial analysts examine this ratio to determine the company's leverage.
A company's leverage is a measure of financial stability that indicates how much debt the company has incurred in relation to its available resources. Leverage is important to both creditors and stockholders. Creditors consider a company's leverage when determining whether the company can qualify for financing, while stockholders consider leverage to determine how much risk is involved in purchasing the company's stock. Debt-to-asset ratio is one of the most common measures of a company's leverage.
About Debt to Asset Ratio
A company can determine its debt-to-asset ratio by finding the sum of all of its assets and dividing by the sum of all of its liabilities. This ratio requires a company to use the book value of each of its assets when finding the sum. To determine the total of its liabilities, the company must find the sum of the amount it owes to all debtors without including any future interest payments.
When the majority of a company's assets are financed, the debt-to-asset ratio will be high. High debt-to-asset ratios may prevent creditors from offering new financing because they may worry that the company doesn't have sufficient assets to repay the debt. In the event of liquidation, companies must pay third-party creditors before they pay shareholders, so higher ratios may also prevent potential investors from purchasing stock in the company.
Though the debt-to-asset ratio is a simple computation, the measure of financial health it provides isn't always realistic. Potential investors and creditors use the ratio to determine the funds that would be available to repay them if the company were to file bankruptcy. However, because the debt-to-asset ratio considers the book value of assets instead of their market value, it doesn't accurately predict the amount of money the company would gain during liquidation.
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