This debt-to-capital ratio calculator is an excellent tool that calculates how much leveraged a company is relative to its total capital. In this article, we will cover what is debt-to-capital ratio, how to find it, and what is the debt-to-capital ratio formula. We will also explore a real example of how to calculate the debt-to-capital ratio. Keep reading!
What is the debt to capital ratio?
The debt-to-capital ratio is an indicator that measures the contribution of debt to a company's capital that is used to found operations. It compares all debt that generates interest to the total capital (interest-bearing debt plus equity). Consequently, a high value indicates high leverage, whereas a low value indicates operations to be founded by shareholders' equity.
On a corporate level, companies can go to the stock exchange to sell a percentage of their ownership in return for cash. This is known as equity financing. However, they have a second way, and it is called debt.
The main difference between the two is that you have to pay a loan amortization when you get debt, which is spread between the principal and its interest. With the equity financing option, no payment is obligatory.
The debt-to-capital ratio is a way to link both ways of financing and assess the contribution of each one into the business structure.
What is a good debt-to-capital ratio?
From the above explanation, we understand we have two extreme scenarios:
The company has a high contribution from the equity, in which case shareholder's ownership might have been diluted severely.
The company has a high contribution from debt, in which case interest to be paid might be too high for the company to be profitable.
Besides, such a ratio that includes debt and equity is very dependent on the industry in which the company operates. Mining companies that use debt for buying heavy machinery will not have a comparable debt-to-capital ratio with other industries like cloud computing.
Thus, a good debt-to-capital ratio only becomes acceptable if the company produces enough earnings to cover the interest that its debt generates and keeps shareholders happy. Yes, a company can have a good debt-to-capital ratio and still not manage properly their debt.
As a suggestion, you do not want a higher than 0.7 debt-to-total-capital ratio because it indicates that your company is mainly financed by debt. We will come back to these results later, after checking the debt-to-capital ratio formula.
Debt-to-capital ratio formula
Perhaps, while you were reading, you asked yourself, all great Arturo but How to calculate debt-to-equity ratio?. Well, let's explain it.
To calculate the debt-to-equity ratio, we need two parameters:
- Interest-bearing debt; and
- Shareholders' equity — Including preferred stock, common stock, and minority interest.
To get the debt-to-equity ratio, we need to divide interest-bearing debt by total capital, which is both all interest-bearing debt and equity added up together. The whole formula is as follows:
debt-to-capital ratio = interest-bearing debt / (interest-bearing debt + shareholders' equity)
Shareholders' equity shall also include mezzanine equity, preferred stock, and minority interest.
As mentioned above, a high debt-to-capital ratio would indicate high leverage. However, suppose the company generates earnings that cover the interest comfortably. There should not be any problem with having a debt-to-capital ratio of over 0.7 in that case.
How to calculate debt-to-capital ratio?
Go to the balance sheet of the company you are interested in and check the liabilities section.
Select only the short/long-term liabilities which generate interest. Examples of these accounts are bonds, capital lease obligations, bank overdrafts, the current portion of the long-term debt, among any item that bears interest.
Sum them all. Now, you have interest-bearing liability.
Go to the equity section and extract the shareholder's equity. It must include minority interest and preferred stock.
Use the debt-to-capital ratio formula indicated above.
Debt-to-capital ratio: Real example
- Current portion of long-term debt: 27 MUSD (million US dollars).
- Operating lease liabilities, current: 175 MUSD.
- Long-term debt, net of current portion: 7,560 MUSD.
- Operating lease liabilities, non-current: 1,544 MUSD.
Interest-bearing debt: 9,306 MUSD.
- Uber shareholders' equity: 12,266 MUSD.
- Mezzanine equity (Redeemable non-controlling interest): 787 MUSD.
- Non-redeemable non-controlling interest: 701 MUSD.
Shareholder's equity including non-controlling interest and minority interest: 13,754 MUSD.
Then, if we use our cool debt-to-capital ratio calculator, we get:
Debt-to-capital ratio = 0.4
That's it, we've found the debt-to-total capital ratio of UBER! There are other debt analysis ratios that can give a more complete picture of the financial situation: debt-to-income ratio, debt-to-asset ratio, and debt-to-equity calculator. The current result indicates that UBER gets 40% of its capital from interest-bearing debt.
As mentioned before, this is a static picture because it only includes balance sheet information. To assess whether or not the company goes in the bankruptcy direction, investors have to complement their analysis with the interest coverage ratio and the revenue growth.
In conclusion, the debt-to-capital ratio calculator is an insightful tool. Still, it could be way more powerful if it is combined with our vast set of financial calculators.
What is a good debt to capital ratio?
An excellent debt to capital ratio is under 0.7. However, this ratio only indicates where the capital comes from, either from debt or equity. Thus, although a high debt to capital ratio shows a considerably leveraged company, this might not be a problem if the company enjoys an interest coverage ratio over 3.
How do I calculate debt-to-capital ratio?
To calculate debt to capital ratio, follow these steps:
- Go to the balance sheet of the company and check the liabilities section.
- Select only the liabilities (short and long) which generate interest. Examples of these are short/long-term liabilities, bonds, capital lease obligations, bank overdrafts, the current portion of the long-term DEBT, among any item that bears interest. Sum them all. Now, you have the interest-bearing liability.
- Go to the equity section and extract the shareholder's equity. It must include minority interest and preferred stock.
- Divide the interest-bearing liability by the total shareholder's equity, the add the interest-bearing liability to get the debt to capital ratio.
How to find debt-to-capital ratio?
Most of the time, you only require the balance sheet of a company. Here, you would need to go to the liabilities section for finding out the components of the debt to capital ratio. However, sometimes, for finding all the interest-bearing debt, you have to go to the financial statement notes. Operating leases and financial leases might be there and shall be considered if they generate interest.
What is a bad debt-to-capital ratio?
A really bad debt-to-capital ratio is the one from a company that cannot pay its interest with its earnings. A high debt-to-capital ratio might be considered risky in the case of a sudden decrease in operating cash flows. However, suppose the interest are usually well covered by earnings. In that case, a company could run with high debt to capital ratio indefinitely.