What is the Debt to Asset ratio?
As part of Solvency ratio analysis, it becomes very important to understand how the company’s assets are funded.
This is when the Debt to Asset ratio comes to the play.
Also called as Debt Ratio, it is one of the most used ratio by Investors and Lenders to understand the company’s Solvency position.
In the previous resources, will looked at Debt to Capital ratio that explained about the company’s strategy around its Capital Structure. It explained how much of the company’s capital is funded via Debt.
In this resource, let us understand everything we need to know about the Debt to Asset ratio.
Debt to Asset ratio Meaning
Debt to Asset ratio basically indicates how much of the company’s assets are funded via Debt.
If a Company has Total Assets of $100 and Debt of $50, the Debt ratio is $50/$100= 0.5
Hence, 50% of the Assets are funded via Debt.
Debt to Asset ratio Formula
The formula for Debt to Asset ratio is quite logical.
We take Total Debt in the numerator and Total Assets in the denominator.
To understand the numerator and denominator better, we need to pay attention to the below aspects.
Total Debt is nothing but the amount borrowed by the company from various lenders. The value can be obtained from the Balance Sheet of the company.
One must pay attention when calculating Total Debt since not all the liabilities reported by the company are considered as Debt.
Below are the few items that are reported on the Balance Sheet but are not considered as Debt for the sake of calculation.
- Accounts Payable
- Accrued Expenses
- Other Short term Payable
Similarly below are the most important items that are considered as Debt.
- Short term borrowings
- Long term borrowings
- Bonds Liability
- Short term Capital lease obligations
- Long term Capital lease obligations
- Total Assets simply refers to the overall employed by the company.
- The value for Total Assets can be obtained from the Balance Sheet.
- For the calculation, we need to take both current assets and non-current assets in the denominator.
Debt to Asset ratio Example
Let us now look at how to apply this formula with an example.
As part of this resource, we have continued our example which we discussed as part of Debt to Capital Ratio.
Consider the two companies – Alpha Inc. and Beta Inc.
We are given the Balance Sheet extract for both the companies.
To calculate the Debt ratio, we need
- Total Debt
- Total Assets
Both the value in the case of the above companies can be obtained from the Balance Sheet.
In our given example, companies have only two types of Debt, Short term debt and Long term debt.
Let us add both the value and arrive at Total Debt
- Alpha Inc.= $30+ $150 =$180
- Beta Inc.= $20 + $100 = $120
Similar to Total Debt, even Total Assets can be obtained easily.
All we need to do is take the total of Total Asset value from the Balance Sheet.
- Alpha Inc.= $500
- Beta Inc.= $1,000
Now that we have both the values, we can calculate the ratio.
Debt to Asset Ratio = Total Debt /Total Assets
- Alpha Inc.= $180 / $500 = 0.36x or 36%
- Beta Inc.= $120 / $1,000 = 0.12x or 12%
As evident from the calculations above, the Debt ratio for Alpha Inc. is 0.36x while its 0.12x for Beta Inc.
What this indicates is that in the case of Alpha Inc.,36% of Total Assets are funded via Debt.
On the contrary, in the case of Beta Inc., only 12% of Total Assets are funded via Debt.
Clearly, among both, Alpha Inc has high Debt on its Balance Sheet. This may put an Interest burden on the Company.
Since Beta Inc, has a low DA ratio, it enjoys greater flexibility to fund its Assets via Debt, if required.
Debt to Asset ratio Using Excel
In our next example, let us calculate the Debt to Asset ratio using Excel.
We have used the Financial Statements of Walmart for the sake of explanation
You can download the Debt to Asset ratio template using the below option.
After you download you will see the consolidated Balance Sheet of Walmart and related calculations.
To calculate the ratio, we need
- Total Debt
- Total Asset
Let us calculate each item and understand the example better.
As you can see from the Balance Sheet above, Walmart has below liabilities that form part of Total Debt.
Let us add all such items and arrive at Total Debt.
- Short term debt
- Current Lease obligations
- Long term debt
- Non current Lease obligations
Total Debt = $5,255 +$2,605 +$39,657 +$6,683 = $54,170
Unlike the numerator, we can calculate the denominator quite easily.
Total Assets can be obtained from the Balance Sheet directly.
In the case of Walmart,
Total Assets = $219,295
Now that we know the numerator and denominator, we can easily arrive at the ratio.
Debt to Asset ratio = Total Debt / Total Asset
= $54,170 / $219,295 = 25%
As you can see from the calculations above, Walmart has Debt ratio of 25%.
What this indicates is around 25% of the Total Assets of the company are funded via Debt.
To know if this ratio is good or bad, we need to understand how is the ratio profile for the industry as a whole. Also, we need to look at how the ratio has changed historically.
Debt to Asset ratio Interpretation
Has already discussed, Debt ratio indicates how much of the company’s Assets are funded via Debt.
Let us look at hoe to interpret if this ratio is very high or low.
High Debt to Asset ratio
- If a company has a high debt to asset ratio, it indicates the significant amount of the company’s assets refunded via Debt.
- This may indicate the company may have a relatively higher Debt on its Balance Sheet.
- Also calculating other solvency ratios like Debt to Capital or Debt to Equity ratio helps us to understand how levered is the company.
- If a company earns returns that are greater than the cost of debt, then Ideally the company raises Debt to fund its assets.
- Under such a situation the Debt to Asset ratio will naturally be high.
Low Debt to Asset ratio
- On the contrary, if a company has a low debt asset ratio, it shows that most of the Assets are funded via Equity Capital.
- This may indicate that the company has a relatively lower Debt on its Balance Sheet.
- This will boost the overall solvency position of the company.
- Since the company has a better Debt profile, if required, the company may raise additional capital via Debt in the future at a low cost.
As already highlighted, to understand if the ratio is good or bad, we need to look at how the ratio has moved historically.
Let us look at the case Home Depot, a US-based Home Improvement Retailer.
Below is the Debt ratio profile for the company for the past 5 years.
As evident from the chart above, the ratio has been increasing significantly.
Back in 2015, the Debt to Asset ratio for Home Depot was almost 42%.
Subsequently, most of the company’s asset was funded via Debt. Hence, the ratio gradually increased.
The company may have access to low-cost Debt. Hence the Debt level relative to the overall asset as increased over the period.
Clearly, the company’s strategy is to raise Debt to fund its Assets.
For the year ending 30th June 2019, Home Depot Debt ratio was almost 67%
Hence, performing a historical trend analysis not only helps us in understanding how the ratio as moved, but also the overall company strategy.
Comparison With Similar Companies
Apart from performing the trend analysis, one should also look at how the ratio is different for companies in a similar or different sector.
In this resource, let us look at the Debt ratio profile for prominent companies and understand how different they are when compared to one another.
As evident from the chart above, clearly Internet-based companies like Facebook and Google have a low Debt to Asset ratio. This is in line with what we have seen in the Debt to Capital ratio as well.
Generally, these companies are not capital intensive. They fund most of their assets via Equity Capital.
Facebook almost has no Debt on its Balance Sheet.
Google has a very nominal Debt. Hence, Google Debt to Asset ratio is 2%.
Oil and Gas company
ExxonMobil is a US-based multinational oil and gas company.
Although oil and gas companies are capital intensive, the Debt ratio profile for ExxonMobil is impressive.
Only 10% of the overall Assets of the company is funded via Debt.
Retail and e-commerce companies
As already seen in the example above, Walmart has a Debt to Asset ratio of almost 25%.
On the contrary, the Home Improvement retail company, Home Depot has the highest Debt ratio of almost 66%
This clearly shows the different strategies applied by both companies.
As we look at the profile for Amazon, the ratio is not significantly high.
The Debt to Asset ratio for Amazon is moderate at 30%.
Microsoft vs Apple
Other prominent tech companies like Microsoft and Apple also have a comfortable Debt ratio in the range of 25% to 30%.
As evident from the chart above, Microsoft as a Debt to Asset ratio 27% while the premium smartphone maker Apple has Debt to Asset ratio of 32%
In the case of US-based Electronic Vehicle maker Tesla, the ratio is relatively higher.
Unlike other companies, Tesla has a very troublesome Balance Sheet and suffers losses.
The Debt to Asset ratio for Tesla is almost 40%
Clearly, among all the companies under the discussion, Tesla and Home Depot tends to have a high Debt to Asset ratio. This can be attributed to various other factors apart from the above mentioned ones.
So that was everything you need to know about Debt to Asset ratio.
Learn other important Solvency Ratios or browse through the below recommended resources.