This ratio measures the extent to which the assets of the business are funded by loans and other borrowings including trade creditors. Assets can be funded either from borrowings (including trade creditors) or from owners’ equity (including retained profits). A business uses its assets to generate income which is used to pay off creditors and interest on borrowings (among other things). If the asset base is not large enough, it is possible that insufficient income might be generated to cover all borrowing costs.
It is generally considered risky to have a high proportion of assets funded by debt and a proportion of 0.5:1 (or 50%) or below might be considered acceptable.
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