What Is Capital Debt Ratio? (Full Details)

What is Capital Debt Ratio?

The capital debt ratio, also known as the debt-to-equity ratio, is a financial metric used to evaluate a company's capital structure. It is calculated by dividing a company's total debt by its total equity. This ratio helps investors and analysts understand how much of a company's financing comes from debt and how much comes from equity. A high capital debt ratio indicates that a company has a greater amount of debt relative to equity, while a low ratio indicates the opposite. The ideal ratio varies depending on the industry and the company's financial goals, but generally a lower ratio is considered more favorable.

What Is A Good Debt Capital Ratio?

The ideal debt-to-equity ratio varies depending on the industry and the company's financial goals. Generally, a lower ratio is considered more favorable, as it indicates that a company has a greater amount of equity relative to debt and is less leveraged.

For example, a ratio of less than 0.5 is considered to be conservative and a ratio of 1 is considered to be more aggressive. However, it is important to note that the ideal ratio also depends on the company's ability to generate cash flow to pay off its debt.

For example, a stable, mature company in a low-growth industry may be able to handle a higher debt-to-equity ratio than a rapidly growing start-up in a high-growth industry. It's also important to compare a company's debt-to-equity ratio to that of its peers in the same industry as well.

In general, a good debt-to-equity ratio should be considered in the context of a company's overall financial health and ability to generate cash flow to pay off its debt.

What Is Debt-to-Capital Ratio Formula?

The debt-to-capital ratio formula is:

Debt-to-Capital Ratio = (Total Debt) / (Total Debt + Total Equity)

Where:

  • Total Debt = Long-term debt + Short-term debt
  • Total Equity = Shareholder's equity + Retained earnings

This ratio is also known as the capital structure ratio, which measures the proportion of a company's financing that comes from debt and the proportion that comes from equity.

It is important to note that debt-to-capital ratio is different from debt-to-equity ratio, as debt-to-capital ratio includes both short-term and long-term debt and takes into account the whole capital structure of the company, while debt-to-equity ratio only includes long-term debt and shareholder's equity.

What If Debt to Capital Ratio Is Less Than 1? (What does a low debt to capital ratio mean?)

If a company's debt-to-capital ratio is less than 1, it means that the company has more equity than debt in its capital structure. This is generally considered a positive indication of the company's financial health, as it suggests that the company has a lower level of leverage and is less reliant on debt financing.

A low debt-to-capital ratio can indicate that a company has a strong financial position, with a healthy balance between debt and equity. It also implies that the company has a good capacity to generate cash flow to pay off its debt and can also be an indication of a strong creditworthiness.

However, it's important to note that a low debt-to-capital ratio doesn't necessarily mean that a company is profitable or that it will be a good investment. It's just an indicator of the company's capital structure and the company's ability to service its debt. Other factors such as the company's profitability, earnings growth, and management quality should be considered to evaluate a company's overall financial health.

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