One Balance Sheet, Three Ratios, and Only One of Them Has a Ceiling

Assets are at book value, and book value is a history

The denominator is what the accounts say the assets are worth, which for a building bought decades ago and depreciated ever since bears no relation to what it would sell for. Two companies with identical premises can therefore report very different ratios depending on when each bought, and a revaluation improves the number without a single thing happening in the world. The distortion runs the other way too: goodwill from an acquisition sits in total assets at what was paid, which flatters the ratio until the day it is written down and the ratio deteriorates sharply for a reason that was already true.

Not everything on the liabilities side is debt

Total liabilities includes money owed to suppliers, deferred revenue from customers who have paid in advance, provisions for future costs and accrued wages, none of which behaves like borrowed money. Trade payables carry no interest and no covenant; deferred revenue is a promise to deliver rather than to repay. A ratio built on all liabilities therefore answers a different question from one built on interest-bearing debt alone, and lenders usually mean the second when they say leverage. Say which of the two a figure uses, because a subscription business with a year of prepayments can look heavily indebted while owing nothing to anybody with a loan agreement.

Frequently asked questions

What level of debt to assets is safe?

It depends on how steady the earnings are and how sellable the assets. A utility with contracted revenue and physical infrastructure can carry a ratio that would be reckless for a fashion retailer whose main asset is stock that goes out of season. The question the ratio cannot answer on its own is whether the business can service what it owes, which is a matter of cash flow rather than of balances — so read it alongside interest cover and debt service coverage, and treat a comfortable balance sheet with thin coverage as the more dangerous of the two combinations.

Do leases count as debt?

Under the accounting standards now in force in most places, yes: a lease puts a right-of-use asset on one side and a lease liability on the other, so both the numerator and the denominator grow. That change alone moved the reported ratios of retailers and airlines substantially without altering a single contract, which is worth remembering when comparing figures across the years in which it took effect. Comparing a company's ratio today with its ratio from before the change compares two different accounting worlds.