Debt to Capital

Debt to capital is a business’s debt divided by its total capital, where total capital is that same debt added to shareholders’ equity. The numerator is therefore one of the two amounts the denominator sums, and while both are positive the answer falls between zero and one, so it reads directly as the share of the funding base that came from lenders rather than from owners. Total debt-to-capitalization is the same measure under a longer name.

The family this member belongs to, and the base each of the others divides by, sit at debt ratios. The pool in the denominator is the debt-plus-equity total held at capital invested, taken before that entry’s excess-cash adjustment.

The Formula and the Bound It Creates

debt to capital  =  debt / (debt + equity)

Debt is whichever borrowings figure has been chosen for the numerator. Equity is total shareholders’ equity read off the same balance sheet at the same date.

Putting the numerator inside its own denominator is what separates this measure from the rest of the family. The quotient cannot reach one while equity is positive, because the denominator exceeds the numerator by exactly the amount of that equity. A debt to capital figure can therefore be quoted as a percentage of the funding base. A debt to equity figure cannot, because its denominator is only one leg of that base.

debt to capital  =  (debt to equity) / (1 + debt to equity)

debt to equity   =  (debt to capital) / (1 - debt to capital)

The two carry the same information on different scales, so either converts into the other with no further facts, provided both were built on the same debt figure.

The bound holds only while both inputs are positive. An accumulated deficit large enough to turn equity negative makes total capital smaller than the debt, so the ratio passes one, and a deficit larger than the debt turns the denominator negative and the reading stops meaning anything.

Which Debt Goes in the Numerator

Which debt goes on top moves the answer more than anything else in the calculation, and the label does not say which choice was made. Three builds are in circulation: every liability on the sheet, the interest-bearing borrowings alone, or long-term debt alone. Whichever is picked has to be contained in the debt figure that joins equity in the denominator, or the measure loses the bound that makes it readable.

Trade payables and accruals are where the builds part company. On the debt ratio they sit inside a total-liabilities numerator, the choice worked through at debt to asset ratio analysis. They fall outside a borrowings numerator, which is the build this measure’s name points at.

A filed credit agreement shows how precisely that line gets drawn once the number binds. A revolving syndicated facility agreement that Pilgrim’s Pride Corporation filed with the Securities and Exchange Commission defines its total debt to capitalization ratio as consolidated total debt divided by total capitalization. Total capitalization is then defined as the sum of all Indebtedness that would appear as a liability on a consolidated balance sheet prepared in accordance with GAAP plus total stockholders’ equity, and consolidated total debt as the aggregate amount of all outstanding Indebtedness for borrowed money, other than letters of credit or bank guarantees to the extent undrawn, of a type required to be reflected on a balance sheet (Pilgrim’s Pride Corporation, Revolving Syndicated Facility Agreement).

Read those definitions together and the numerator is narrower than the debt leg of its own denominator: borrowed money on one side, all Indebtedness on the other. The numerator still sits inside the denominator, so the bound survives, but the denominator picks up obligations the numerator never counts.

The same agreement’s definition of Indebtedness carves accounts payable incurred in the ordinary course of business out of its deferred purchase price clause only where those payables are on normal commercial terms and not overdue by more than 60 days (Pilgrim’s Pride Corporation, Revolving Syndicated Facility Agreement). The carve-out is drafted as a condition rather than as a blanket exemption, so a question about payables aging can turn into a question about the definition.

Which balances count as borrowings at all, and how the part falling due inside a year is split off, sit at long-term liabilities.

Where a US Firm Meets Debt to Capital

No statement caption reports this ratio, so a preparer meets it in loan documents rather than in the financial statements.

The Pilgrim’s Pride agreement attaches a form of compliance certificate whose schedule sets the calculation out as numbered blanks: consolidated total debt on one line, the two legs of total capitalization beneath it, and the ratio as item two divided by item three, entered to 1.00 rather than as a percentage (Pilgrim’s Pride Corporation, Revolving Syndicated Facility Agreement). Filling those blanks off a trial balance is the work, though the certificate calls for that schedule only for periods following a collateral cure date.

A collateral cure date is the date the company delivers notice that it is not, or will not be, in compliance with the agreement’s financial maintenance covenant and elects to guarantee and secure the facility instead (Pilgrim’s Pride Corporation, Revolving Syndicated Facility Agreement).

That maintenance covenant is an interest coverage test rather than this ratio: the company will not permit the interest coverage ratio as of the last day of any fiscal quarter to be less than 3.50:1.00 (Pilgrim’s Pride Corporation, Revolving Syndicated Facility Agreement). The schedule that goes in with every quarterly and annual delivery of financial statements is the one demonstrating compliance with that covenant, which leaves the debt to capitalization calculation as the conditional one.

The ratio gates action as well as reporting it, and from that same date. Following the collateral cure date, additional unsecured indebtedness is permitted only where, immediately after giving effect to it on a pro forma basis, no event of default is continuing or results from it and the total debt to capitalization ratio shall be less than 0.55:1.00 (Pilgrim’s Pride Corporation, Revolving Syndicated Facility Agreement). A borrower near that line is asking a definitional question before a financing one.

A credit agreement’s definitions chain usually runs much further than the three terms behind this ratio, and how far it can run is the ground covenants covers.

A Worked Example

Say a business funds one base of capital, and both measures are read at four different splits of it.

     debt        equity   total capital   debt to capital   debt to equity
  400,000     1,600,000       2,000,000              0.20             0.25
  800,000     1,200,000       2,000,000              0.40             0.67
1,200,000       800,000       2,000,000              0.60             1.50
1,600,000       400,000       2,000,000              0.80             4.00

Each row adds the same amount of debt. Debt to capital moves by the same amount every time, because the base it divides by never changes. Debt to equity moves by more at every step, because its base shrinks by exactly what its numerator gains.

What Debt to Capital Is Confused With

Total debt-to-capitalization. The same measure under a longer name. Nothing in the arithmetic changes, so figures carrying either label compare, provided both were built the same way.

Debt to equity. The same numerator over a different base, equity alone rather than debt plus equity, which is why it has no ceiling. Its arithmetic relationship to the assets-over-equity form is set out at equity multiplier.

Capital structure. The mix of the two legs rather than a number put on it, and which instruments belong to which leg is settled at capital structure rather than by the ratio.

Working capital. Total capital here is a funding base read down the right side of the balance sheet. Net working capital is current assets less current liabilities, a different question with a different answer, held at net working capital.

Common Questions

If covenant compliance schedules are what pile up at quarter end, Accountably’s trial task puts a trained offshore preparer on a block of that work first.