Debt ratio is a leverage ratio that tells about the percentage of debt against total assets. The higher the ratio is, the more risky a business is considered because higher interest will have to be paid on higher debt. Assume that a business has total assets of $900,000 and total liabilities of $500,000 and $400,000 of total stockholder’s equity.
The debt ratio will be as follows:
Debt ratio = Total Liabilities/ Total Assets
Debt ratio = $500,000 / $900,000 = 55.55%
Normally a 50% debt ratio is considered balanced but for some businesses, the higher debt ratio is maintained to avail higher tax savings as higher interest cost is charged on profits to lower the taxable income.
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