Debt to asset ratio
The financial condition of the company is a condition for its activity and the key to a stable position in the market. It reflects the state of financial resources that allow the company to freely maneuver money, to ensure an uninterrupted production process, as well as sales processes, expanding the range and improving its products or services.
In a modern economy, it is difficult to overestimate the role of financial analysis in the successful development of an enterprise. The financial analysis allows you to assess the financial condition of the enterprise, as well as predict its further development based on the calculation of various indicators of liquidity, financial stability, solvency, turnover, and many others.
One of the financial tools that can be used in such analysis is the debt to asset ratio, which characterizes the dependence on external sources of financing (i.e. what share in the entire capital structure is borrowed funds). This ratio can be represented as follows:
Analysis and example
Although it is very simple and quick to calculate, this financial ratio is one of the items creditors look at when determining how much a company owes, the ability to pay off its debt, and determine whether any more loans should be provided to the company. Investors also want to ensure that the company is solvent, capable of meeting current and future financial responsibilities, and can provide a return on their investment.
Obviously, every company wants to be less reliant on debt. Thus, it is desirable that this value is closer to zero than one (100%). For instance, a 24% ratio would tell us that a majority (76% of the assets are financed through equity). At the same time, a reasonable amount of debt helps companies to grow faster.
Finally, if you see that this ratio goes beyond one, it means that the company does not have enough assets to cover its liabilities. Accordingly, most investors and creditors will try to avoid investing in such an organization. At the same time, it is beneficial for the investors when a company gets funds through other financial institutions and not them to make more profit. However, here it is important to evaluate whether the benefit outweighs the risks associated with large amounts of debt. For creditors, though, high debt is never good because it means that the company already has large obligations before other entities.
Now, consider the Balance sheet of the Walmart company below:
As you can see, the assets for the year 2020 add up to $236,495,000 and the total debt is $154,943,000. Therefore, the debt to asset ratio is calculated as follows:
Debt to assets ratio = $154,943,000 / 236,495,000 = .6552 = 65.52%
Based on the information you just learned, can you tell what this figure means? Yes, this figure indicates that 65.52% of the company’s assets are financed by debt. If we compare it to the previous year (63%), we can say that Walmart has slightly more debt than it did before. However, in 2021, this ratio slightly improved.
It is also helpful to compare this ratio not only for the company itself over a span of time but also with its competitors. When comparing with other companies, it is important to note that if companies are using different inventory or depreciation methods, the results will be affected accordingly. Thus, before you start the comparison, consider all the factors that could affect the final debt to asset value.