All companies are required by law to track their financial information. This is beneficial to not only customers who want to know that a place of business is reputable, but the business itself too. This is because it helps them know how well they are doing at any given period of time. Here comes along the debt to asset ratio that we are going to discuss below.
To track a company’s status, financial experts use a series of different financial equations that make understanding the numbers easier. And one of the most common of them that gets calculated is the debt to asset ratio.
What Is a Debt to Asset Ratio?
A debt to asset ratio is an equation that represents how much debt a company has in comparison with all of their assets. It is calculated by dividing the total debt by the total assets to get a percentage. The total debt is calculated by adding up all of the long-term and short-term debt that a company has.
But sometimes, companies do two different debt to asset ratios to see where they stand on a long-term or short-term basis. To clarify accounting terms that are used in financial work, it should also be mentioned that debt is often referred to as liabilities.
Who Needs a Debt to Asset Ratio the Most?
The main reason that companies need to know their debt to asset ratio is to bring in more capital. They can do this through investors or a loan from a bank. The ratio has to be less than 50% to be considered acceptable. However, it is also dependent upon the type of industry that a company is in.
Some industries have to carry a higher amount of debt because of the immense cost of their products. An example of this is the technology industry. This area requires a mass exportation of parts from all over the world that are all very costly.
How Much Is Spent on a Debt to Asset Ratio Calculation?
- Fortunately, it doesn’t cost much to get this calculation. If a company has been keeping accurate accounting records, then it is just a matter of printing out a balance sheet to see all of the totals. Then, you can use a calculator to get the percentage.
- Many banks and investment brokerages track this number on a regular basis if a company is publicly traded. This action helps them see how it is doing. If it gets to be too high, companies might need to find a way to pay down some before they go into debt further.
- This isn’t always possible if the company is already struggling financially. This is why they need the extra loan or investment income in the first place though. But banks and investors have a good reason to require it. A company that has too much debt is less likely to be able to pay a loan back. They also have slight chances to have good dividends to provide to the shareholders.
4 Ways Your Company Can Reduce the Debt to Asset Ratio
1. The Vital Accurate Accounting
Accurate accounting is crucial to lowering a debt to asset ratio. If any of the information is wrong, it could make it impossible for a company to get approved for a loan from any bank.
Also, investors might sell off their shares or not buy any new ones. This decreases the chances of having extra income for any new projects.
2. Limiting Debt Is Also Important
Sometimes, companies who are desperate to start a new project begin it before their past projects can start to turn a profit. And this can end up increasing their debt to asset ratio. Consequently, it decreases their chances of receiving an approval for financial backing when they need it the most.
Small companies are the most deeply affected by this. They already have less assets to start with than a large corporation does.
3. Paying Off Debts Will Also Help
This is mostly because it lowers the debt to asset ratio quickly. Of course, the amount that it lowers is dependent upon the amount of debt that is paid off.
- Companies that have a long list of debts, but little income, can start by paying off small bills that they have accumulated.
- Or they can start making small payments towards large debts to get the total amount down some.
4. Look to the Future
It is also crucial that companies think on a long-term basis before they take on any new debt. Paying off a small debt in order to have a decreased debt to asset ratio to get a loan from a bank isn’t always a good idea. It will only put the company further in debt than it was before.
Also, besides this important factor, banks look at the long-term financial records of a company. So they are going to notice if a company is basically surviving off of loans instead of working on increasing their profit margin.
As you can see, there is a lot to consider when it comes to achieving a healthy debt to asset ratio. It has to be low enough for banks to consider a company healthy enough to risk giving a loan to them. And shareholders will be closely monitoring it too. So it is important that companies keep careful tabs on their accounting to ensure that they always have an accurate record of their debt. They also need to pay off as much of their debt as they can, even if it is just small amounts at a time. And lastly, companies need to think on a long-term basis if they are considering adding more debt on a regular basis because it will make their company look less profitable.
If you or someone that you know has ever worked on calculations for this ratio, feel free to comment below. We would love to hear more about what worked for you.
The images are from depositphotos.com.