Debt Ratio

Debt is a natural part of business. The most volume (number of transactions) of debt occurs with the simple purchase of materials (inventory) or supplies on account. Every business buys on account whether it is a traditional vendor account like that found in retail or simply using a credit card. A third party provides credit which creates debt for the business. The debt ratio reflects the percentage of assets covered by debt. The formula is as follows:

Debt  Ratio  = Liabilities
                         Assets   

Most small businesses have difficulty finding private capital for equity to fund assets especially assets for the expansion (growth) of a business. Assets are funded from two sources. The first source is equity which is customarily composed of the sale of ownership shares – stock and retained earnings (which are the lifetime retained profits from operations). The second source of capital to buy assets is from debt. Borrowing money is easier than obtaining capital equity. It is especially easier if the debt is collateralized like that required with bank loans. This chapter in the business ratio series explains the two underlying parts of debt, short and long-term liabilities. In addition,

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