How to Interpret Debt To Worth Ratio

When it comes to the life and success of your business there’s only one way to determine it. That way is called debt to worth ratio. The debt to worth ratio is considered the “acid test” of all businesses. This is because the ratio of total debt to total equity is a clear indication of a business’ ability to thrive successfully. Determining your debt to worth ration extends beyond make a numerical calculation. You have to be able to understand what that number means to interpret your debt to worth ratio correctly.

Things You’ll Need:

  • All data regarding debt
  • Correct information of the value of assets and net worth (ownership level).
  • Calculator or PC spreadsheet ability

Step 1

You will need to compile a clear mark up of debt to worth ratio. You need all financial information to compute your ration. This is critical to the process. The formula is not completed. Divide the total sum of debt by the total sum of tangible net worth. The result can be used whether assessing a business entity or an individual’s personal situation. For example, a business or individual with $200,000 in debt and $50,000 in tangible net worth has a debt to worth ratio of 4.

Step 2

Add only your tangible items in the net worth figure. Most businesses and individuals also have accumulated intangible net worth items. These items are believed to have a certain value but cannot be added in these calculations for an accurate interpretation. For example, a business that has had success in operations will most times have a “goodwill” factor. This estimates the value of their brand or public image in their market and community. However, goodwill is not tangible and cannot be turned into cash.

Step 3

Critically analyze the results calculation after the debt to worth ratio. A high number is indicative that the business or individual is less stable and strong as a company or person with a lower debt to worth ratio number. A business or person with a debt to worth ration of 1 is more stable than a business or person with a debt to worth ratio of 6. A debt to worth ration of 1 says that the business or individual has a sufficient net worth to pay off debt whenever the need may arise. Oppositely, a business or person with a net worth ratio of 6 has debt that could be eliminated by liquidating their assets and current net worth.

Step 4

Estimate your borrowing needs. Compare your needs to the debt worth ratio of other businesses or individuals. A lower debt to worth ratio enjoy non restricted borrowing abilities whole those with higher debt to worth ratios are higher risks for lenders.

Step 5

Let an experienced analyst examine your investments. Take their opinion on your debt to worth ration. There can be valid reasons a business has a high debt to worth ratio.

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About the Author: Marie Mayle is a contributor to the MegaHowTo team, writer, and entrepreneur based in California USA. She holds a degree in Business Administration. She loves to write about business and finance issues and how to tackle them.

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