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 dividing it by the total capital. Total capital is all interest-bearing debt plus shareholders' equity, which may include items such as common stock, preferred stock, and minority interest.
Key Takeaways
- Measurement of a company's financial leverage, calculated by taking the company's interest-bearing debt and dividing it by total capital.
- All else equal, the higher the debt-to-capital ratio, the riskier the company.
- While most companies finance their operations through a mixture of debt and equity, looking at the total debt of a company may not provide the best information.
The Formula for Debt-To-Capital Ratio
Debt-To-Capital Ratio=Debt + Shareholders′ EquityDebt
The debt-to-capital ratio is calculated by dividing 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 idea of a company's financial structure and whether or not the company is a suitable investment. All else being equal, the higher the debt-to-capital ratio, the riskier the company. This is because a higher ratio, the more the company is funded by debt than equity, which means a higher liability to repay the debt and a greater risk of forfeiture on the loan if the debt cannot be paid timely.However, while a specific amount of debt may be crippling for one company, the same amount could barely affect another. Thus, using total capital gives a more accurate picture of the company's health because it frames debt as a percentage of capital rather than as a dollar amount.
Example of How to Use Debt-To-Capital Ratio
As an example, assume a firm has $100 million in liabilities comprised of the following:- 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
- 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. If the portfolio manager looks at another company that had a debt-to-capital ratio of 40%, all else equal, the referenced company is a safer choice since its financial leverage is approximately half that of the compared company's.
As a real-life example, consider Caterpillar (NYSE: CAT), which has $36.6 billion in total debt as of December 2018. Its shareholders’ equity for the same quarter was $14 billion. Thus, 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
Unlike the debt-to-capital ratio, the debt ratio divides total debt by total assets. The debt ratio is a measure of how much of a company’s assets are financed with debt. The two numbers can be very similar, as total assets are equal to total liabilities plus total shareholder’ equity. However, for the debt-to-capital ratio, it excludes all other liabilities besides interest-bearing debt.