What is a debt ratio and why it's a key financial metric

What Is A Debt Ratio and Why It’s A Key Financial Metric

Here at Direct Route Ltd, we are passionate about supporting businesses who are struggling with unpaid invoices and debt concerns. Today we’re going to share with you our guide to debt ratio. It’s a key financial metric that everyone should know about in order to protect their finances moving forward. We’ll be here to support you if you do need assistance with this topic or any other financial matters moving forward.

What is a Debt Ratio?

A debt ratio reveals whether a company has loads and whether the financing they have acquired is more or less in total than its assets. You can calculate the debt ratio for any company by dividing the total liability by the total assets. A higher figure suggests that there is a higher level of debt financing, which can suggest that you need to check out your finances in order to change this ratio. Debt ratio is used for almost any type of organisation, including individuals and government organisations. Investors may use this to decide if a company is a good one to invest in, and lenders find it useful to calculate the risk of loans.

When we talk about debt ratio, you’ll often hear this figure labelled as good or bad. It’s hard to use these words without giving more context, so keep this in mind if you hear this title given to a debt ratio. Investors will typically look for a ratio of between 0.3 and 0.6 for best results. A figure below 0.4 is considered good, whereas one above 0.6 will suggest that you’ll have a harder time borrowing money. Of course, carrying absolutely no debt could indicate other issues in the business, so it’s all about learning more about the complete picture of a company’s finances to get a good idea of whether you should work with them in any manner.

What is a Good Debt Ratio?

As far as the risk associated with lending money or investing in a company, we typically recommend trying to keep your debt ratio below 0.4. When it reaches above 0.6, this suggests that your finances might not be as secure, and it will make it harder for you to borrow money. Debt collection agencies will naturally look at this figure if they are trying to collect money from you, but they’ll also take into account your payment history and relationships.

While it might sound contradictory, investors typically don’t buy stock from companies with a debt ratio of zero. This shows that you don’t have the operations in place to warrant borrowing money, which means the investment it likely to pay off for them. Some companies now focus on the debt-to-equity ratio, which is a better indication of your complete financial status.

Why is Debt Ratio a Key Financial Metric?

Investors and lenders both use debt ratios to get a good idea of your overall financial operations. However, especially when it comes to investing, they’ll want to look at the overall health of your bank balance and operations. Larger companies typically can negotiate more than smaller ones, but over time, you can work hard to change your debt ratio. You’ll also want to make sure you don’t have endless unpaid invoices to avoid further financial issues, as these are a common factor when it comes to bad debt ratio.

How to Improve Your Debt Ratio

Working with a debt recovery agency is one way in which you can start to improve your debt ratio. If you have endless overdue payments, this can have a huge impact on your low debt ratio. Take the time to calculate your debt to income ratio, so that you have a good idea of where you stand currently. Remember, especially if you are running a large business, this figure isn’t going to change overnight. In time, your total debt ratio will be able to improve, and you’ll find that a good debt ratio is within your reach. If you do find you need to borrow money and are having issues securing this type of financing, make sure you can present to them a full overview of your finances so that you have a greater chance of securing your financing.

As you can see, debt ratio is an important metric when it comes to financing and investing. You’ll want to make sure you keep an eye on this ratio at all times, so that you have a good idea about where you stand when it comes to your finances. Our team will be here at any time to support you with this task and ensure that you are in full control of your finances to keep thriving as a business owner. Contact us today for more information on this topic or to discuss any questions you have about debt ratio.