Can anyone please explain what is Debt Ratio and how to calculate it?
This is a very important ratio to know for all inventory business owners. Please take the time to calculate it!
The debt ratio indicates how much of the company’s assets were obtained by the issuance of debt.
If the ratio is 1, it means that all of the assets were financed by the issuance of debt.
If the ratio is 0.6, it means that 60% of the company’s assets were financed by debt.
***Only you can determine what ratio is comfortable for you, but it’s important to understand how much debt you incurred for the unsold inventory plus cash in your business. Some sellers have more debt than they realize***
The formula for the debt ratio is:
As a reminder, Liabilities generally include loans and credit card debt.
Assets generally include cash (checking balances) and unsold inventory.
Let’s say I sell an item on Amazon at a competitive price. After fees I receive $20. If I had to liquidate today and lower the price after fees I would receive $15. If I just look at cost for the item I paid $5, cost $1 to process and a $1 to send to Amazon so I have $7 invested. Would I use the $20, $15, $7 or $5 to value the inventory asset for debt ratio?
Inventory is typically valued at lower of cost or market.
The $5 cost is lower than market ($20 or $15). The additional $2 ($1 to process and $1 to send) are components of COGS and not on the balance sheet because you record those expenses when incurred. In other words, $5 is the value of unsold inventory for that item.
The only clarification I would add (because this can get confusing!) is ending inventory is not “taxed” but instead is an important component of calculating cost of goods sold. Unsold inventory is on the balance sheet (which is what this ratio is based on) and sold inventory is on the P&L as Cost of Goods Sold. (Calculation is: Beginning inventory + purchases – ending inventory = COGS).
Anna Hill is the founder of Accounting We Will Go, a firm that provides accounting and bookkeeping services along with training for Amazon sellers.