What Is the Bond Ratio?
The bond ratio is a financial ratio that expresses the leverage of a bond issuer by examining the value of bonds outstanding and when they come due. Leverage refers to any borrowed capital, for example, debt issued as bonds or other debts.
Understanding the Bond Ratio
The bond ratio formally expresses the ratio of the bonds issued by a firm as a percentage of its total capital structure. Capital structure refers to how a company finances its operations and growth using different sources of funding, namely debt and equity.
The numerator of the bond ratio captures the total value of any long-term bonds that the company has issued with maturity dates greater than one year. Short-term debt obligations, i.e. those with maturity dates in under one year, are not considered in this calculation. The denominator captures the entirety of the firm's capital structure utilizing its enterprise value (EV), however excluding cash and short-term debt. Enterprise value is a measure of a company's total value, often used as a more comprehensive alternative to equity market capitalization. EV includes in its calculation the market capitalization of a company yet additionally its debts.
Bond Ratio = (Value of bonds due after one year)/(Value of bonds due after one year + value of equity capital)
Interpreting the Bond Ratio
Debt can be a more favorable means to finance operations because of its tax advantages. It likewise permits companies to retain ownership, unlike giving equity, which permits outside shareholders to possess a piece of the firm. Despite the fact that debt enjoys some upper hands over equity in the capital structure, too much debt can become burdensome on any firm. On the off chance that revenues decline for the firm, because of a recession or less demand for its products, for example, the firm will in any case be required to pay back its bondholders. The bond ratio permits investors to analyze the company's debt load and helps form an assessment on the firm's ability to repay its debts and avoid bankruptcy in the event of a decline in revenue.
Generally speaking, a bond ratio that exceeds 33% is viewed as above-average leverage. The common exception to this applies to utility companies, which regularly have ratios at this or a higher level. The bond ratio just is one of numerous ratios that are used to examine the financial health of bond issuers, and should be analyzed related to other ratio analysis. Since it is important to realize how well a business is dealing with its debt, the accompanying leverage ratios are likewise often used: Debt/EBITDA, EBIT/Interest Expense, and Debt-to-Equity (D/E) Ratio.
- A bond ratio greater than one-third is indicative of above-average leverage taken on by a company.
- The bond ratio is used to measure the financial leverage of a firm based on its level of long-term debt it has issued.
- The ratio divides the notional value of long-term bonds by a firm by its enterprise value, excluding cash or short-term debts.