Debt to Capital Ratio
Let us not get confused with complex financial terms and formulas, as most of them tend to bamboozle our brains and we end up knowing nothing. We can figure out the meaning of D/C ratio very easily by just referring to the term itself. Here’s an explanation:
Debt:The term debt to capital ratio is made up of two financial factors, which are debt and capital. The factor debt implies the amount of money that a business owes to its creditors. There are several different types of debts that a business can have, such as loans, credit extensions from suppliers, installment payments for fixed assets, mortgage loans, credit cards, etc. In short, all long term and short term obligations of the company constitute the debt.
Capital: Capital is any kind of money invested in order to run the business. The sources with the help of which capital for every type of business organization is raised is different. The D/C ratio is drastically affected as a result. The capital usually consists of the total amount invested, fixed assets (which are not secured as collaterals), other investments by investors, common stock, etc.
The debt to capital ratio calculation is extremely simple, though much more complex formulas have been derived by businesses for their own convenience. You can use the following debt to capital ratio formula for the purpose of simple calculation:
Debt to Capital Ratio: Total debts that are to be paid or are payable/ Total capital Invested
This formula gives you a two sided ratio, such as 2:3, which might not prove to be exactly resourceful, in some cases. In such cases, you may also convert the ratio into a percentage. For this purpose, multiply the fraction by 100. According to the ratio 2:3, the total liabilities payable would become 66.66% of the total capital. You may also read more about a similar ratio, which is known as debt to equity ratio.
Debt to Capital Ratio Variants
There are several different variants of debt to capital ratio. The above variant, where the ratio is expressed in a percentage is one such prominent example. While using this variant of the formula, it is also possible that the output figure tallies up to some weird figure such as 200%. Such figures that exceed 100 indicate that the total debt or liabilities exceed the amount of capital. As mentioned above, the nature of the business organization affects the formula as well as output of the calculation. Thus, if you are calculating this ratio of a businessman or a sole trading concern, you will need to simply divide the amount of debts with the capital. In such a case, you will see that debts are very low and never exceed the amount of capital. The same variant of the formula is applicable to partnership firms as well. In contrast, large joint stock companies are bound to have larger ratios, with debts exceeding the capital. Joint stock companies also include all share amounts in the capital (which in reality are debts), or different amounts of capitals supplied by finance organizations.
Debt to Capital Ratio Analysis
There is no set of concrete recommendations for this ratio. Thus, the best way to analyze this ratio is to have a look at the constituents of the ratio. There are many companies who consider insurance payments as debts in calculation of this ratio. Some businesses also include prepaid expenditures as capitals in the ratio. In general, as a thumb rule, the best financial management and financial planning is observed when the debt is lesser than the capital. In cases of joint stock companies, an equal ratio is much better, as it depicts a very good use of loan and credit facilities.
Get more information here.
