What is the debt-to-capital ratio?
The debt-to-capital ratio can tell you exactly that. Helping you to understand your businesss capital structure, solvency, and degree of financial leverage, it can be an important metric for business owners and investors to get to grips with. Find out more about debt-to-capital ratio analysis with our comprehensive article. Debt-to-capital ratio definition  The debt-to-capital ratio (D/C ratio) measures the financial leverage of a company by comparing its total liabilities to total capital. In other words, the debt-to-capital ratio formula measures the proportion of debt that a business uses to fund its ongoing operations as compared with capital. This financial metric can help you understand a range of things about your business, including capital structure and financial solvency. So, if you want to understand how well your business could handle a potential downturn in sales revenue, debt-to-capital ratio analysis could be ideal. Theres a simple debt-to-capital ratio formula you can use to work out this financial ratio:  Debt-to-Capital Ratio = Debt / Debt + Shareholders Equity  As you can see, its a relatively simple calculation  all you need to do is divide your firms total debt by its total capital (total debt + shareholders equity). Its important to make note of a couple of points when it comes to the debt-to-capital ratio formula. Debt includes all short and long-term liabilities, while the shareholders equity figure should be a sum of all company equity, from common and preferred stock to minority interest. If that all sounds too complicated, dont fret  there are a wide range of online debt-to-capital ratio calculators that you can use to work out your D/C ratio, rather than calculating it by yourself. All you need to do is plug in your figures and the debt-to-capital ratio calculator will do the rest. Debt-to-capital ratio example  Now, lets look at an example of the debt-to-capital ratio to see how it works in practice. Imagine that Company A lists $40,000,000 in short-term liabilities and $70,000,000 in long-term liabilities on their balance sheet. Theyve also issued $20,000,000 in preferred stock, $5,000,000 in minority interest, and have around 8,000,000 outstanding shares trading at $10 per share. Using all that information, you can complete the debt-to-capital ratio formula like so:  Debt-to-Capital Ratio = ($40M + $70M) / ($40M + $70M) + ($20M + $5M + (8M x $10)) = 0.512  In other words, 51.2% of Company As operations are funded with debt, rather than capital. This makes it a relatively risky proposition, as the business is aggressively financing growth activities with debt. Using debt-to-capital ratio analysis  At its core, the debt-to-capital ratio is a measure of risk. Financing your businesss day-to-day operations through debt has an intrinsic level of risk, because the principal (plus interest) must be paid back to the lender. As a result, firms with a higher debt-to-capital ratio are inherently riskier prospects, as a downturn in sales could lead to potential solvency issues. Having said that, a higher debt-to-capital ratio isnt always a negative. If the loans are used in the right way, it could lead to sizable returns for shareholders. Limitations of the debt-to-capital ratio  Its also important to think about the limitations of debt-to-capital ratio analysis. In some senses, this financial metric will be affected by your companys accounting practices. This is because entries on your financial statements are likely to be based on historical cost accounting, rather than their current market values. If you use these entries to draw a debt-to-capital ratio interpretation, they may not accurately reflect your businesss true financial leverage. As such, its incredibly important to use the correct values when running a debt-to-capital ratio analysis. We can help  GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.