ACCOUNTING TERMS - ACCOUNTING DICTIONARY - ACCOUNTING GLOSSARY
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DEBT RATIO Definition
DEBT RATIO measures the percent of total funds provided by creditors. Debt includes both current liabilities and long-term debt. Creditors prefer low debt ratios because the lower the ratio, the greater the cushion against creditors losses in liquidation. Owners may seek high debt ratios, either to magnify earnings or because selling new stock would mean giving up control. Owners want control while "using someone elses money." Debt Ratio is best compared to industry data to determine if a company is possibly over or under leveraged. The right level of debt for a business depends on many factors. Some advantages of higher debt levels are:
- The deductibility of interest from business expenses can provide tax advantages.
- Returns on equity can be higher.
- Debt can provide a suitable source of capital to start or expand a business.
Some disadvantages can be:
- Sufficient cash flow is required to service a higher debt load.
- The need for this cash flow can place pressure on a business if income streams are erratic.
- Susceptibility to interest rate increases.
- Directing cash flow to service debt may starve expenditure in other areas such as development which can be detrimental to overall survival of the business.
Formula: Total Liabilities / (Total Liabilities + Stockholders Equity)
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ORDINARY COURSE OF BUSINESS is the actions or results that would logically be expected in the regular or planned operating activities of a business as opposed to extra-ordinary transactions or activities, e.g. trade liabilities, capital asset procurement or revenue and its sources.
NON-CASH FINANCING & INVESTING is where information about transactions and other events that do not result in any cash flows during the financial year but affect assets and liabilities that are recognized must be disclosed in the financial report where the transactions and other events: a. involve parties external to the entity; and b. relate to the financing or investing activities of the entity.