Debt-To-Capital Ratio
What Is the Debt-To-Capital Ratio?
The debt-to-capital ratio is a measurement of a company's financial leverage. The debt-to-capital ratio is calculated by taking the company's interest-bearing debt, both short-and long-term liabilities and partitioning it by the total capital. Total capital is all interest-bearing debt plus shareholders' equity, which might incorporate things like common stock, preferred stock, and minority interest.
The Formula for Debt-To-Capital Ratio
Instructions to Calculate Debt-To-Capital Ratio
The debt-to-capital ratio is calculated by partitioning a company's total debt by its total capital, which is total debt plus total shareholders' equity.
What Does Debt-To-Capital Ratio Tell You?
The debt-to-capital ratio gives analysts and investors a better thought of a company's financial design and whether the company is a suitable investment. All else being equivalent, the higher the debt-to-capital ratio, the riskier the company. This is on the grounds that a higher ratio, the more the company is funded by debt than equity, and that means a higher liability to repay the debt and a greater risk of forfeiture on the loan on the off chance that the debt can't be paid opportune.
In any case, while a specific amount of debt might be devastating for one company, a similar amount could barely influence another. In this way, utilizing total capital gives a more accurate image of the company's wellbeing since it outlines debt as a percentage of capital as opposed to as a dollar amount.
Illustration of How to Use Debt-To-Capital Ratio
For instance, assume a firm has $100 million in liabilities contained the accompanying:
- Notes payable $5 million
- Bonds payable $20 million
- Accounts payable $10 million
- Accrued expenses $6 million
- Deferred income $3 million
- Long-term liabilities $55 million
- Other long-term liabilities $1 million
Of these, main notes payable, bonds payable, and long-term liabilities are interest-bearing securities, the sum of which total $5 million + $20 million + $55 million = $80 million.
With respect to equity, the company has $20 million worth of preferred stock and $3 million of minority interest listed on the books. The company has 10 million shares of common stock outstanding, which is currently trading at $20 per share. Total equity is $20 million + $3 million + ($20 x 10 million shares) = $223 million. Utilizing these numbers, the calculation for the company's debt-to-capital ratio is:
- Debt-to-capital = $80 million/($80 million + $223) = $80 million/$303 million = 26.4%
Assume this company is being considered as an investment by a portfolio manager. On the off chance that the portfolio manager takes a gander at one more company that had a debt-to-capital ratio of 40%, all else equivalent, the referred to company is a more secure decision since its financial leverage is roughly half that of the compared company's.
As a genuine model, think about Caterpillar (NYSE: CAT), which has $36.6 billion in total debt as of December 2018. Its shareholders' equity for a similar quarter was $14 billion. Consequently, its debt-to-capital ratio is 73%, or $36.6 billion/($36.6 billion + $14 billion).
The Difference Between Debt-To-Capital Ratio and Debt Ratio
In contrast to the debt-to-capital ratio, the debt ratio partitions total debt by total assets. The debt ratio is a measure of the amount of a company's assets are financed with debt. The two numbers can be basically the same, as total assets are equivalent to total liabilities plus total shareholder' equity. Be that as it may, for the debt-to-capital ratio, it rejects any remaining liabilities other than interest-bearing debt.
Limitations of Using Debt-To-Capital Ratio
The debt-to-capital ratio might be impacted by the accounting shows a company utilizes. Frequently, values on a company's financial statements depend on historical cost accounting and may not mirror the true current market values. In this manner, it is vital to be certain the right values are utilized in the calculation, so the ratio doesn't become distorted.
Features
- Measurement of a company's financial leverage, calculated by taking the company's interest-bearing debt and isolating it by total capital.
- All else equivalent, the higher the debt-to-capital ratio, the riskier the company.
- While most companies finance their operations through a combination of debt and equity, taking a gander at the total debt of a company may not give the best data.
