The debt ratio is a concept from the world of finance that refers to the measurement of the percentage of debt of a company or individual in relation to its total assets.
It is primarily used to analyze the financial health of a company, as it allows investors and creditors to see how much an organization owes to other entities compared to what it owns.
Why is it important to calculate the debt ratio?
A correct measurement and analysis of the debt ratio serves to make better financial decisions. This means that entrepreneurs have a better idea of how much debt they can or cannot take on in the short and medium term.
For example, if you are considering starting a new project, knowing the current status of the business is ideal to establish whether or not it is really worthwhile to apply for bank loans.
It is also a way of being aware of the risk of bankruptcy. If large imbalances are found during the calculation of the debt ratio, it is best to consider a financial review and restructuring.
Knowing the exact percentage of indebtedness will also serve to establish a payment plan for debt consolidation. If necessary, a consumer proposal could be suggested to the creditors.
How to calculate the debt ratio
Calculating a company’s debt ratio is a relatively simple task. But it must also be a very careful and thorough process to get a clear and unambiguous picture of the organization’s true financial statements.
This means that entrepreneurs must know how to calculate the debt ratio correctly in order to effectively move forward with any growth plan.
Nowadays, there are some software that can do this analysis easily and automatically, so it is advisable to learn how to handle them if you are not sure how to carry out the process.
To properly manage a financial recovery program, it is important to seek guidance from expert advisors.
On the other hand, this calculation is also useful for investors, as it allows them to have a better understanding of the risks and possible returns associated with investing in a specific company.
To calculate the debt ratio, factors such as the state of the market depending on the sector in which the company operates must be taken into account.
This value is calculated by dividing a company’s total debt by the sum of its debt and equity. The formula is as follows:
(Liabilities / Equity)
Short-term or long-term percentages can also be calculated using the following two formulas:
Long-term debt ratio = (Non-current liabilities / Shareholders’ equity).
Short-Term Debt Ratio = (Current Liabilities / Shareholders’ Equity)
Current liabilities are debts maturing in less than one year. Non-current liabilities, on the other hand, are those whose maturity extends for more than one year.
This measurement is presented as a percentage for ease of interpretation. To calculate this ratio correctly, exact data from a company’s balance sheet is needed.
The balance sheet is a financial document that shows the assets, liabilities, equity and other financial aspects related to the company. All this information is essential to calculate a company’s debt ratio accurately.
Basically, the recommended debt ratio should always be less than 1%. If in the results you notice that the percentage is higher, it is advisable to take actions to return the company’s budget balance and have a good debt ratio.
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