What to Do
There are many variations of this ratio, including those which divide long-term debt into separate parts. Many analysts see this as unnecessarily complex, preferring a straightforward formula that
divides total liabilities by total capital (liabilities plus stockholders’ equity):
Example:
Suppose a company’s total liabilities amount to $4.5m, and stockholder equity is $7m. Total capital is therefore $11.5m. The debt-to-capital ratio is therefore:
The formula can also be expressed as total debt divided by total funds: the result will be the same.
What You Need to Know
- Stockholders’ equity includes common stock, preferred stock, minority interest, and net debt.
- The definition of “debt” varies, but it should include capital leases.
- Opinions vary about an acceptable debt-to-capital ratio—some say 60% or less, others 40%.
- If a company goes bankrupt, debt holders are paid first—so stockholders are most at risk from a high debt-to-capital ratio. But the risk may be acceptable if return on assets is greater than interest payments on debts.
- Debt-to-capital is not the same thing as debt-to-capitalization (debt measured against total market capitalization, which reflects the movement of stock prices).
Where to Learn More
Web Site:
Investopedia.com (search for debt-to-capital ratio): www.investopedia.com
