There are three primary financial statements published by companies every year. The statements are published for the sake of full disclosure. The balance sheet provides an overview of company assets, liabilities and stockholders' equity. Financial analysts use it to measure a firm's capital. Most companies need to raise capital, and they can either sell the company through a stock offering or take on debt in the form of a bank loan or bonds. One statement metric analysts calculate when analyzing company capital is the debt ratio. There are two commonly used debt ratios.
Obtain the balance sheet. The balance sheet is published in the annual report that can be obtained by requesting a hard copy from the company's investor relations department or by downloading it from the company's website.
Turn to the balance sheet. Specifically, you are looking for three different data points. You will need total assets, total liabilities and total stockholders' equity. Assume these are $100,000, $70,000 and $30,000, respectively.
Calculate the debt-to-equity ratio. The ratio is calculated by dividing total liabilities by total stockholders' equity. The higher the ratio, the more debt the company has compared to equity; that is, more assets are funded with debt than equity investments. In this example, the calculation is $70,000 divided by $30,000 or 2.3.
Calculate the debt-to-assets ratio. Debt to assets looks specifically at the amount of debt compared to the amount of assets the company has on the books. In theory, banks and lenders like to know they can sell assets off if the loan cannot be repaid. This is why the debt to assets ratio is important to many creditors including bond holders. The debt-to-assets ratio is calculated by dividing total liabilities by total assets. The higher the ratio, the more debt is being used in order to fund assets. In this example, the calculation is $70,000 divided by $100,000 or .7.
Compare these ratios against other companies in the same industry for the best insights about company performance and acceptable debt levels.
- NetMBA: Financial Ratios
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James Collins has worked as a freelance writer since 2005. His work appears online, focusing on business and financial topics. He holds a Bachelor of Science in horticulture science from Pennsylvania State University.