Question

What do we use the debt ratio for? What is the calculation for the return on assets?

Answer 1

What do we use the debt ratio for?

Introduction:

Debt ratio is the ratio that shows the firm’s total liability as a percentage of its total assets. In simple words we can say that it shows the firms ability to meet its liability with its assets. If the liabilities are higher than assets then it is considered as risky for the lenders.

Formula:

Debt Ratio = Total Liabilities / Total Assets

Interpretation with an example:

If John wants to expand his business and he approached the bank for loan. The bank computed his debt ratio. His financials shown that the total assets were $ 2,00,000 and total liabilities was $ 50,000.

Debt ratio would be : $2,00,000/ $ 50,000 = 0.25

As in this example we can see that the liabilities are only 0.25 times of the total assets, the bank can easily rely on the John and can give loan to him.

There is no standard benchmark for debt ratio. Each industry chooses its own benchmark.

The firms with lower debt ratio is considered as conservative.

What is the calculation for the return on assets?

Definition:

Return on assets shows that how much profit a company Is generating from its assets. It is shown in percentage.

Calculation:

Return on Assets = Net Income / Average Assets *

*Average Assets = Assets at the beginning of the period + Assets at the end of the period / 2

Let us take an example:

		Company A
		($)
Net Income	A	5,00,00,000
Assets at the beginning of the period	B	51,00,00,000
Assets at the end of the period	C	49,00,00,000
Total Assets	D=B+C	1,00,00,00,000
Average Assets	E = D /2	50,00,00,000
Return on Assets		10.00%

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