Debt-to-Capital Ratio
Candlefocus EditorTo calculate a company's debt-to-capital ratio, take the company's total interest-bearing debt and divide by the total capital of the company. Total capital is defined as the sum of the company's long-term and short-term debt (including interest) plus its equity. The result of this equation gives an indication of the company's overall financial leverage, which reflects how much debt the company carries in relation to the overall financial resources available.
For example, if a company has $10,000 in long-term debt, and $20,000 in equity, its total capital is equal to $30,000. If the company has $2000 in short-term debt, its interest-bearing debt is equal to $12,000 ($10,000 + $2000 = $12,000). Using the equation provided above, the company's debt-to-capital ratio is 40 percent ($12,000 / $30,000 = 0.4, or 40%).
In general, the higher the debt-to-capital ratio, the riskier the company is. The more debt the company takes on, the more vulnerable it is to defaulting on its loans and not having enough to cover its operational costs. Therefore, the debt-to-capital ratio is an important tool used by lenders and investors, as it offers valuable insights into the company's financial standing and riskiness.
Apart from financial leverage, the debt-to-capital ratio also offers insight into the company’s ability to cover its short-term debts, as well as its pricing power. Companies with high debt-to-capital ratios generally have less pricing power compared to those with lower ratios, as they are more vulnerable to changes in interest rates. Additionally, companies with high ratios are usually more dependent on external financing and have less financial flexibility.
Overall, the debt-to-capital ratio is an important measurement that provides insight into a company's financial leverage and risk. By understanding a company's ratio, lenders, investors, and other financial analysts can get a better idea of the company's financial health, as well as its vulnerability or sustainability over the long-term.