Question

One of the ratios that will allow us to know the state of the company and provide us information about whether we should invest in the company or not is the debt ratio.

The debt ratio is a financial ratio that measures the extent of a company’s leverage. The debt ratio is defined as the ratio of total debt to total assets, expressed as a decimal or percentage. It can be interpreted as the proportion of a company’s assets that are financed by debt.

A ratio greater than 1 shows that a considerable portion of debt is funded by assets. In other words, the company has more liabilities than assets. A high ratio also indicates that a company may be putting itself at a risk of default on its loans if interest rates were to rise suddenly. A ratio below 1 translates to the fact that a greater portion of a company's assets is funded by equity. (Hayes, 2019).

The debt ratio for 2018 was 0.54 and in 2017 it was 0.58. If we compare both years, this decrease in the ratio determines that the company has decreased the amount of liabilities compared to assets. This situation can determine that the company's investment in assets has been better in 2018 than in 2019.

Finally, I have calculated the debt ratio for Exxon Mobile Company, being a company that offers the same service and that can be a competitor. In 2018 the debt ratio was 0.43 (147,668 / 346,196) and in 2017 the debt ratio was 0.44 (154,191 / 348,691). This ratio shows that this company uses its resources better. However, at ConocoPhilips, there is a better evolution from 2017 to 2018.

	ConocoPhillips
	2018	2017
Debt Ratio (Total liabilities / total assets)	0.54	0.58
Calculations	37,916 / 69,980	42,561 / 73,362

Question:

• You note that Exxon because has a lower debt ratio, it uses its resources better. I don't follow you. Can you elaborate?

Answer 1

If we follow the definition of Debt ratio, it says ratio of debts over assets. The lower the debt, lower will be the ratio. Since debt is a liability, a lower debt means a better financial position for the company.

Now in case of Exxon Mobile Company, as said in the question above, the debt ratio was 0.44 in 2017 and 0.43 in 2018.

For your information 0.44 can be written as 44/100 and 0.43 can be written as 43/100

So for 2017,

Debt ratio = Total Debt / Total Assets => 44/100

It means for every asset value of 100, the company had Debt value of 44

Now for 2018,

Debt ratio = Total Debt / Total Assets => 43/00

It means for every asset value of 100, the company had Debt value of 43 which is lesser that that of 2017.

Hence it means the company is using its resources better which has led to decrease in value of debt.