Debt Ratio Definition and Explanation

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Quick Definition

Measures the ability of a company to manage its short and long term debt.

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Debt Ratio Formula

Explanation of Debt Ratio

The Debt Ratio measures the percentage of Short Term Debt to Long Term Debt, a useful way to uncover a company’s reliance on short term or long term debt.

Importance of Debt Ratio

If the Debt Ratio is increasing, this may be a sign the company has not been able to secure long-term, lower interest financing, instead having to secure short-term, higher interest short term financing.

If the Debt Ratio is decreasing, it is generally a positive sign, showing the company may be paying off its Short-Term Debt or possibly refinancing its Short Term Debt into Long Term Debt. Refinancing is not a bad sign in itself, as they may simply be trying to reduce their interest payments. The Long-Term Debt needs to be monitored over time to see if they are reducing the total value of the Long-Term Debt.