DEBT RATIO Definition

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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)

Learn new Accounting Terms

BUDGET is an itemized listing of the amount of all estimated revenue which a given business anticipates receiving, along with a listing of the amount of all estimated costs and expenses that will be incurred in obtaining the above mentioned income during a given period of time. A budget is typically for one business cycle, such as a year, or for several cycles (such as a five year capital budget). Of the many kinds of budgets, a CASH BUDGET shows CASH FLOW, an EXPENSE BUDGET lists expected payments of money, and a CAPITAL BUDGET shows the anticipated payments for CAPITAL ASSETS. See FORECAST, PROJECTION.

CP is an acronym with many possible meanings, e.g., Capacity Planning, Central Procurement, Change of Plan (insurance), Claims Procedure (insurance), Commercial Paper, Community Property, Consumer Products, Contingency Plan, Contract Price, Change Proposal, etc.

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