What it measures
– The debt-to-capital ratio is a simple leverage metric that shows the share of a company’s capital structure financed with interest-bearing debt. It frames debt as a proportion of the firm’s total capital (debt plus shareholders’ equity), so you can compare leverage across companies of different sizes.
Definition and formula
– Debt-to-capital ratio = Debt / (Debt + Shareholders’ equity)
– “Debt” here usually means interest-bearing liabilities: short-term borrowings (notes payable), long-term debt, bonds, and similar obligations that require interest payments.
– “Shareholders’ equity” includes common equity, preferred stock, retained earnings and minority interest (as reported on the balance sheet).
Why it’s useful
– Shows how much of a company’s capital base is funded by creditors versus owners.
– Helps assess financial risk: all else equal, a higher ratio indicates more leverage and potentially higher risk of distress.
– Use it alongside other ratios (interest coverage, debt-to-EBITDA, debt ratio) and industry benchmarks rather than alone.
Step-by-step: how to calculate
1. Pick a date (usually quarter- or year-end) and use the balance-sheet values for that date.
2. Gather interest-bearing debt items (short- and long-term). Exclude non-interest current liabilities (e.g., accounts payable) unless you choose a broader definition.
3. Gather shareholders’ equity components (common stock, preferred stock, retained earnings, minority interest if applicable).
4. Use the formula: Debt / (Debt + Equity).
5. Express as a decimal or percentage.
Quick checklist before you compute
– Use the same reporting date for debt and equity.
– Decide whether to use book values (balance sheet) or market value for equity — be consistent and note the choice.
– Confirm which liabilities are interest-bearing and include only those if following the standard definition.
– Adjust for off‑balance-sheet items (capitalized leases, guaranteed obligations) if material.
– Compare to industry peers and historical company levels.
Worked numeric example (simple)
– Suppose a company’s interest-bearing debt items sum to $80 million.
– Shareholders’ equity components: preferred stock $20 million, minority interest $3 million, and common stock value = 10 million shares × $20 per share = $200 million. Total equity = $20m + $3m + $200m = $223 million.
– Debt-to-capital = 80 / (80 + 223) = 80 / 303 ≈ 0.264 = 26.4%.
– Interpretation: about 26% of the company’s capital is financed by interest-bearing debt; the remainder is equity.
Real-world illustration
– Using the same formula, Caterpillar’s reported figures (Dec 2018) give: debt $36.6 billion and equity $14.0 billion → 36.6 / (36.6 + 14.0) ≈ 0.723 = 72.3%. That indicates a high share of capital funded by interest-bearing debt relative to equity.
How it differs from the debt ratio
– Debt ratio = Total debt / Total assets. It measures what portion of assets is financed by debt.
– Debt-to-capital focuses on interest-bearing debt relative to capital (debt + equity) and typically excludes non-interest current liabilities. The two ratios can be similar but answer different questions.
Key limitations and caveats
– Accounting values: balance-sheet figures are often historical cost, not market values. Using book equity versus market equity can change
change the ratio materially. Book equity is the shareholder equity reported on the balance sheet (accounting measure). Market equity is market capitalization — the current stock price times shares outstanding. Market equity can be much higher or lower than book equity, so substituting it often lowers measured leverage for companies whose stock values exceed book equity, and raises it when market prices are depressed.
Practical implications and other common adjustments
– Off‑balance‑sheet items: Operating leases, until recently treated off‑balance sheet, are now typically capitalized under current lease accounting standards (IFRS 16, ASC 842). If you’re comparing historic statements, add the present value of lease obligations to debt.
– Pensions and other underfunded post‑retirement obligations: If substantial and long‑term, add the funded deficit (pension liability minus plan assets) to debt for a more conservative view.
– Short‑term interest‑bearing obligations: Include short‑term borrowings and current portion of long‑term debt. Exclude non‑interest current liabilities (e.g., accounts payable) unless you have a reason to treat them as financing.
– Contingent liabilities and guarantees: Note them; include if probable and estimable. Otherwise flag as qualitative risk.
– Market vs book equity choice: Use market equity for valuation-sensitive analysis; use book equity for book‑value or accounting comparisons. Report both when useful.
– Timing and comparability: Use the same definitions across peers and time periods. Industry norms vary — utilities tolerate higher debt; tech firms typically carry less.
Worked numeric examples — step by step
1) Basic debt‑to‑capital (book values)
– Formula: Debt‑to‑Capital = Interest‑Bearing Debt / (Interest‑Bearing Debt + Equity)
– Example
Example (book values — step by step)
Assumptions (books): Interest‑bearing debt = $300 million (includes current portion of long‑term debt); Shareholders’ equity (book) = $700 million.
1) Compute capital base
– Capital = Interest‑bearing debt + Equity = $300m + $700m = $1,000m.
2) Compute ratio
– Debt‑to‑Capital = Interest‑bearing debt / Capital = $300m / $1,000m = 0.30 = 30%.
Interpretation: On a book‑value basis the firm finances 30% of its capital structure with interest‑bearing debt and 70% with equity (book). Note that this ignores cash and off‑balance items; see variants below.
Variants and worked examples
A. Market‑value equity (valuation‑sensitive)
– Suppose market capitalization = $1,000m (instead of book equity $700m).
– Capital (market) = $300m + $1,000m = $1,300m.
– Debt‑to‑Capital (market) = $300m / $1,300m ≈ 23.1%.
Key point: Using market equity typically lowers the ratio when market value > book value; report both when useful.
B. Net‑debt variant (focus on net leverage)
– Net debt = Interest‑bearing debt − Cash & cash equivalents.
– If cash = $50m, Net debt = $300m − $50m = $250m.
– Net Debt‑to‑Capital (book equity) = $250m / ($250m + $700m) = $250m / $950m ≈ 26.3%.
Use case: Net measures capture liquidity cushions; disclose whether you used gross or net debt.
C. Capitalizing operating leases (accounting adjustments)
– Suppose remaining operating leases have a present value (PV) of $120m that management capitalizes for analysis (consistent with IFRS 16 / ASC 842 treatment).
– Adjusted debt = Interest‑bearing debt + PV leases = $300m + $120m = $420m.
– Debt‑to‑Capital (adjusted) = $420m / ($420m + $700m) = $420m / $1,120m ≈ 37.5%.
Why do this: Capitalizing leases presents a more comparable debt picture across firms with different leasing policies. State the method and discount rate used to compute PV.
D. Hybrids and convertibles
– Convertible bonds, preferred stock, and similar instruments can be debt‑like or equity‑like.
– Simple approach: treat convertible bonds as debt at book carrying value, disclose potential dilution; run a supplemental “as‑converted” scenario where convertibles are treated as equity to show sensitivity.
– Example: Convertibles = $50m. As‑converted capital = $300m − $50m (if converted) + (equity + shares issued value). Show both presentations.
Step‑by‑step checklist for calculating Debt‑to‑Capital (practical)
1. Gather source documents: latest balance sheet, debt notes, cash flow statement, and lease notes.
2. Identify interest‑bearing debt: short‑term borrowings, current portion of long‑term debt, long‑term debt, capital lease obligations (or lease liabilities).
3. Decide on debt measure: gross debt vs net debt (deduct cash), and whether to include PV of operating leases.
4. Choose equity base: book equity
4. Choose equity base: book equity vs market value. Book equity (shareholders’ equity on the balance sheet) is stable and available; market equity (market capitalization) reflects current investor pricing and can swing widely. Decide whether to include: preferred stock (often treated as a separate category — see step 6), noncontrolling interest (include if you treat consolidated capital), accumulated other comprehensive income (include in book equity unless you have a reason to adjust). Document your choice.
5. Treat convertibles and options. Convertibles can be debt‑like or equity‑like:
– Simple/default: treat convertibles at their carrying (book) value as debt and disclose potential dilution.
– Supplemental: run an “as‑converted” scenario that removes convertibles from debt and adds their equity value to the equity base. If conversion terms imply a different economic value than carrying value, note that assumption.
6. Preferred stock and hybrid instruments. Decide whether to classify preferred stock as debt (if it has mandatory redemption or fixed dividends) or as equity (if perpetual, discretionary dividends). For hybrids (perpetual bonds, PIK instruments), justify treatment and show sensitivity runs if material.
7. Off‑balance and operating liabilities. Consider whether to include:
– Operating lease liabilities (under current accounting they are usually on the balance sheet; if not, estimate the present value).
– Purchase commitments, guarantees, or contingent liabilities if material and reasonably estimable.
– Pension deficits (funded status) if they change leverage materially.
Always document how you estimated these items.
8. Cash and short‑term investments. Decide on gross debt vs net debt:
– Gross debt measure: total interest‑bearing debt.
– Net debt measure: gross debt minus cash and cash equivalents (and sometimes short‑term marketable securities).
Net debt is useful to show true financed position but can be distorted by temporary cash balances (e.g., spinoff receipts). State the date and rationale.
9. Compute totals and ratio(s). Core formulas (choose one and be explicit):
– Debt‑to‑Capital (gross debt): Debt / (Debt + Equity)
– Debt‑to‑Capital (net debt): Net Debt / (Net Debt + Equity)
Where
Debt = sum of chosen interest‑bearing obligations
Net Debt = Debt − Cash and cash equivalents
Equity = chosen equity base (book or market, plus/minus adjustments)
Round to appropriate precision and include units (e.g., millions).
10. Run sensitivity / alternative presentations. At minimum show:
– Gross‑debt presentation
– Net‑debt presentation
– As‑converted (convertibles treated as equity) presentation
– Market‑equity presentation (if you used book equity)
These show how ratio changes under reasonable assumptions.
11. Disclosure checklist. For transparency include:
– Date and sources (balance sheet date, notes cited).
– Items included/excluded with brief rationale.
– Any assumptions used (e.g., present value of leases, conversion price equals carrying value).
– A reconciliation table from reported liabilities to your “Debt” number.
12. Save and archive assumptions. Save a copy of the calculations, the source documents, and a short memo describing methodology so you (or a reader) can reproduce results later.
Worked numeric example