Debt-to-Capital Ratio

The debt-to-capital ratio measures a company’s financial leverage by showing the portion of its capital structure funded by interest‑bearing debt versus equity. Framing debt as a percentage of total capital helps compare leverage and risk across companies and industries.

Formula

Debt-to-Capital Ratio = Debt / (Debt + Shareholders’ Equity)

• “Debt” typically means interest-bearing debt (e.g., short‑term notes payable, bonds, long‑term debt).
• “Shareholders’ Equity” includes common and preferred equity and minority interests (use consistent book or market values as appropriate).

How to calculate

1. Identify interest-bearing debt on the balance sheet (exclude accounts payable, accrued expenses, and other non‑interest liabilities).
2. Determine shareholders’ equity (book value from the balance sheet or market value of equity if comparing market leverage).
3. Plug into the formula and express as a percentage.

Practical example

A firm has:
– Interest-bearing debt: notes payable $5M + bonds payable $20M + long-term debt $55M = $80M
– Shareholders’ equity: preferred stock $20M + minority interest $3M + common equity $200M (10M shares × $20) = $223M

Debt-to-capital = $80M / ($80M + $223M) = $80M / $303M ≈ 26.4%

A lower percentage indicates less leverage relative to capital; a manager comparing this company to one with 40% leverage would view the 26.4% firm as having lower financial risk.

Interpretation and uses

• Higher ratio → greater financial leverage and higher fixed repayment obligations, implying more financial risk.
• Lower ratio → less reliance on debt financing, typically lower default risk but possibly slower growth if equity is favored.
• Use alongside other metrics (interest coverage, cash flow, industry norms) to judge sustainability of debt levels.

Debt-to-Capital vs. Debt Ratio

• Debt-to-capital = interest-bearing debt / (debt + equity). It focuses on capital structure.
• Debt ratio = total debt / total assets. It shows what portion of assets is financed by debt.
  The two can differ because the debt ratio includes all liabilities and relates debt to asset base, whereas debt-to-capital emphasizes financed capital mix and often excludes non‑interest liabilities.

Limitations

• Balance-sheet figures are often historical book values and may not reflect current market values (especially equity). Use market values when appropriate for comparison.
• Definitions of “debt” vary across companies and industries—ensure consistent treatment (e.g., lease obligations, convertible debt).
• Industry capital norms vary: capital‑intensive sectors tend to run higher leverage than service industries.
• A single ratio doesn’t capture liquidity, interest costs, or cash flow adequacy—use in a broader financial analysis.

Bottom line

The debt-to-capital ratio is a straightforward measure of how much of a company’s capital comes from interest‑bearing debt versus equity. It’s most useful when compared across peers and considered with other financial metrics and qualitative factors to assess leverage, risk, and financial flexibility.