Total Debt-to-Capitalization

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Total Debt-to-Capitalization Ratio

Definition

The total debt-to-capitalization ratio measures the proportion of a company’s capital that is financed with debt. It is a solvency and leverage metric that shows how much of the company’s funding comes from creditors (short- and long-term debt) versus owners (shareholders’ equity). A higher ratio indicates greater leverage and a higher risk of financial distress.

Formula

Total debt-to-capitalization = (Short-term debt + Long-term debt) / (Short-term debt + Long-term debt + Shareholders’ equity)

Notes:
– Short-term debt typically includes the current portion of long-term debt and other borrowings due within 12 months.
– Some analysts use net debt (debt minus cash) instead of gross debt; this yields net debt-to-capitalization.

What it indicates

  • Leverage: The ratio quantifies how much debt is used to finance assets relative to equity.
  • Solvency risk: Higher ratios mean the firm relies more on debt and may face greater difficulty meeting interest and principal payments in a downturn.
  • Capital structure insight: Helps compare financing strategies across firms and industries.

Examples

  1. Company ABC
  2. Short-term debt = $10 million
  3. Long-term debt = $30 million
  4. Shareholders’ equity = $60 million

  5. Ratio = (10 + 30) / (10 + 30 + 60) = 40 / 100 = 40%

  6. Company XYZ

  7. Short-term debt = $5 million
  8. Long-term debt = $20 million
  9. Shareholders’ equity = $15 million
  10. Ratio = (5 + 20) / (5 + 20 + 15) = 25 / 40 = 62.5%

Although XYZ has less total debt than ABC, debt makes up a larger share of its capital structure, increasing its financial risk.

Industry context

Acceptable debt levels vary by industry:
– Capital-intensive sectors (utilities, telecommunications, pipelines) often have higher, more sustainable debt ratios due to predictable cash flows.
– Cyclical or less predictable businesses typically maintain lower debt-to-capitalization ratios to preserve flexibility.

Limitations and caveats

  • Timing and accounting differences: Balance sheet values reflect a specific date and can be affected by accounting policies.
  • Off-balance-sheet items: Leases, guarantees, and contingent liabilities may understate true leverage if not included.
  • Cash and liquid assets: Using gross debt ignores cash cushions; net debt measures can provide a different view.
  • Comparability: Use consistent definitions (gross vs net debt, which debt items included) when comparing firms.

How to use it

  • Compare across peers within the same industry.
  • Use alongside other metrics (debt-to-equity, interest coverage, EBITDA-to-debt) to assess solvency and repayment capacity.
  • Monitor trend over time to spot rising leverage or deleveraging.

Key takeaways

  • The ratio shows what portion of a company’s capital structure is financed by debt.
  • Higher values signal greater leverage and higher insolvency risk, but acceptable levels depend on industry and cash-flow stability.
  • Always consider definitions, off-balance-sheet obligations, and complementary ratios when evaluating leverage.