The Debt Ratio
The debt ratio is a way to see how much a business owes compared to what it owns. Think of it like this: If you have 5 toys and you borrowed 2 from your friends, your "toy debt ratio" is 2 borrowed toys out of 5 total toys, or 40%. It's the same with businesses, but instead of toys, we're talking about money and stuff the business owns.
What is the debt ratio
• The debt ratio tells us what portion of a company's stuff (like buildings, money in the bank, etc.) is actually paid for with borrowed money.
Why we need the debt ratio
• It's like checking if the company has borrowed too much. If almost everything a company has is paid for with borrowed money, it might be risky. It's like if you borrowed most of your toys, you'd be worried about giving them back.
Where and When to look at the debt ratio
• Businesses and people who think about investing in them use the debt ratio to check on this risk.
• They look at it often, like every time the company talks about how much money it made.
How to Use the debt ratio
1. Calculate the Debt Ratio: You take all the money the business owes and divide it by everything the business owns (its assets).
2. It’s like dividing the number of borrowed toys by the total number of toys.
3. Understand the Number: A lower ratio means the company doesn't owe a lot compared to what it owns, which is good.
4. A higher ratio means the opposite, the company owes a lot compared to what it owns, which could be risky.
5. Make Decisions: If you're running a business, knowing your debt ratio helps decide if you should borrow more money or start paying back debts. If you're thinking about investing, it helps you decide if the business is safe to invest in.
So, using the debt ratio helps a business or an investor know how much the business relies on borrowed money and if that’s okay or too risky.
It’s like checking if you’re borrowing too many toys and need to start giving some back before borrowing more.
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Disclaimer: The content shared on this blog and in these videos is for informational and educational purposes only. Despite my 30 years of experience as a business owner, I am not a certified financial advisor, accountant, or legal professional. The insights and tips shared are based on personal experiences and should not be taken as professional financial or legal advice. For financial, legal, or professional advice, please consult with a certified professional in the respective field. I disclaim any liability or responsibility for actions taken based on any information found in this blog or these videos.
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