Concepts Behind Debt To Total Assets Ratio
A concern's debts or borrowings are related to its assets through the Debt to Total Assets Ratio. If the concern has borrowed from debtors, shows some liabilities and obtained finance from investors, those are considered as debts for the concern, while the total assets include all the movable and immovable assets which are brought into the concern. Therefore, the Debt to Total Assets Ratio is calculated by dividing the debts with the total assets of the business.
For example, if the debts of a company are estimated to be $30 million and its total assets including its equity investment is $100 million dollars then, the Debt to Total Assets Ratio is given as 0.3. Another ratio namely the Debt to Equity Ratio could also be calculated which considers the shareholders' equity instead of the assets invested in the business, but would give an entirely different value.
Basically, the assets are financed by the creditors who have invested in the business, so the Debt to Total Assets Ratio provides an indication of where these assets are obtained from. Assets can be obtained by other means also, by attracting investors to the business and also by determining the profits made by the concern through which it purchases assets for the business.
Debt to Total Assets Ratio is calculated using the formula
Debt to Total Assets Ratio = Total Debts / Total Assets
It not only provides information on the debts held by the business, which indicates to the share holders and investors the credibility of the company, but it also brings out the total assets of the business, thereby indicated the worth or value of the concern from the point of view of creditors of the business. Assets and liabilities can be exhibited in various forms depending upon how they are calculated.
If the ratio of debts to assets is equal to one, then it is an indication that the amount of liabilities is equal to the amount of assets of a business. If the ratio is more, it is an indication that the liabilities are more while a decreased ratio represents a lower liability. A greater liability indicates that the company has less credibility with low purchasing power and that investors do not find the company attractive. However, if the assets of a company are greater than its liability as shown by a decreased Debt to Total Assets Ratio, then the creditors will perceive it as a positive sign and try to detect ways to invest in the concern, thus adding to its assets.
The accounting systems are intertwined between the assets and liabilities of the business. The greater the liabilities of a concern, the more are its responsibilities to enhance the sales turnover of the business and increase profit, in order to generate greater income. However, if the assets are greater, the Debt to Total Assets Ratio will provide a clear indication of the position of the concern and encourage the share holders to have a better form of investment.
Difficulties Encountered In Debt To Total Assets Ratio
The major problems in Debt to Total Assets Ratio are based on the calculation of assets to liabilities in order to bring out a clear picture of the business concern. A correct Debt to Total Assets Ratio is highly important to be known as it provides whether the assets are greater or liabilities are more. Wrong interpretation of the ratio of Debt to Total Assets Ratio provides problems for investors and creditors. In order to provide a good value of the ratio between debts and assets, it is mandatory that the students know how to calculate the values in the correct format. Students might sometimes get confused with similar terms like debt ratio. To clarify the position of the company to the investors and creditors, the students should be aware of the manner in which the Debt to Total Assets Ratio should be a representative of the assets and liabilities of the business. Having exemplary knowledge is vital for the calculations and the students not getting confused with other similar ratios like Assets Turnover Ratio, and so on.
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