Let’s break down a realistic business scenario with specific numbers to show exactly how this works.
Here’s what our example business owes (Total Debts):
The business has a bank loan of $15,000, outstanding credit card debt of $5,000, and equipment financing of $5,000. When we add all these debts together, the total debt comes to $25,000. This represents all the money this business has borrowed and needs to pay back.
Here’s what our example business owns (Total Assets):
Cash in accounts totaling $20,000, equipment valued at $50,000, and inventory worth $30,000. When we add these together, the total assets come to $100,000. This represents everything of value the business owns that could potentially be sold or liquidated if needed.
Now let’s calculate:
$25,000 (total debt) ÷ $100,000 (total assets) = 0.25
Convert to percentage:
0.25 x 100 = 25%
This 25% debt-to-asset ratio means that for every dollar of assets the business owns, 25 cents was financed through debt. In other words, the business owns 75% of its assets free and clear, with only 25% being financed through loans or credit. This would be considered healthy for most industries, as it shows the business isn’t overly reliant on debt to finance its operations.