Borrowing Ratio Calculation

Definition: Borrowing ratio shows total debt as a percentage of long-term capital (net worth). The higher the ratio, the greater risk will be associated with the firm because the company is burdened with higher borrowings. In other words, more profits of the company will be creamed off to pay the interest on debts and this may mean less profit for equity shareholders. The ratio can be calculate as follows:

Borrowing Ratio = Total borrowings / Net worth
Note: Total borrowings include long-term debt, short-term debt and bank overdraft.

The following information relates to Company XYZ:
Capital at start $150,000
Net profit for the year $110,000
Drawings $10,000
Bank overdraft $20,000
Mortgage loan $200,000

Total borrowings = Mortgage loan + Bank overdraft = 200,000 + 20,000 = $220,000
Capital at end (Net worth) = Capital at start + Net profit - Drawings = 150,000 + 110,000 - 10,000 = $250,000
Borrowing Ratio = 220,000 / 250,000 = 0.88 (This can be expressed as percentage, i.e., 88% geared)

* Next: Cash Flow to Debt Ratio Analysis