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Understand the long-term debt to capitalisation ratio and its importance in assessing a firm’s financial leverage.
The Long-Term Debt to Capitalisation Ratio is a financial metric used to evaluate a company’s capital structure and financial stability. It measures the proportion of a firm’s long-term debt relative to its total capital, which includes both debt and equity.
This ratio indicates how heavily a business relies on borrowed funds to finance its operations and growth, helping investors and analysts assess its leverage, risk exposure, and creditworthiness.
The formula for the Long-Term Debt to Capital Ratio is:
Long-Term Debt to Capital Ratio = Long-Term Debt ÷ (Long-Term Debt + Shareholders’ Equity)
Where:
Long-Term Debt includes loans, bonds, or debentures with a maturity of more than 12 months.
Shareholders’ Equity represents owners’ funds, including share capital, reserves, and retained earnings.
Example:
If a company has ₹300,000 in long-term debt and ₹700,000 in total equity,
Then:
Long-Term Debt to Capital Ratio = ₹300,000 ÷ (₹300,000 + ₹700,000) = 0.30 or 30%
This means that 30% of the company’s total capital comes from long-term borrowing, while the remaining 70% is financed through equity.
Long-term debt generally includes any borrowing that extends beyond one year. Common examples are:
Bank loans with maturities over 12 months.
Bonds and debentures issued to investors.
Lease obligations and mortgage debt.
Any other long-term borrowings from financial institutions.
Short-term debt (e.g., overdrafts or trade payables) is excluded from this calculation because it forms part of the company’s working capital rather than its long-term capital structure.
Total Capital (or Capitalisation) represents the combined long-term sources of funding a business uses to operate.
It includes:
Shareholders’ Equity: ordinary share capital, preference shares, reserves, and retained profits.
Long-Term Debt: loans, bonds, and other borrowings maturing after 12 months.
In some analyses, preferred equity is also included to provide a fuller picture of total capitalisation.
The Long-Term Debt to Total Capitalisation Ratio expresses the same concept but may include preferred equity in total capital.
Formula:
Long-Term Debt to Total Capitalisation = Long-Term Debt ÷ (Long-Term Debt + Equity + Preferred Equity)
Including preferred stock gives a more comprehensive view of how a company’s financing is structured, especially for large corporations or capital-intensive industries.
The interpretation of the Long-Term Debt to Capitalisation Ratio depends on whether the figure is high or low, as it signals differing financial positions:
Indicates heavy reliance on long-term debt.
Suggests higher leverage and interest obligations.
May reduce financial flexibility but can increase return on equity when debt is managed efficiently.
Could be a warning sign for lenders if earnings are volatile.
Indicates lower reliance on debt financing.
Suggests the company relies more on equity financing.
May indicate under-utilisation of cheap debt funding opportunities.
A moderate ratio indicates balanced use of debt and equity.
To properly evaluate this ratio, companies often compare their results with:
Industry Benchmarks: Capital-intensive sectors (e.g., utilities, manufacturing) typically have higher ratios.
Peer Performance: Similar firms within the same industry provide context for comparison.
Historical Trends: Tracking changes over time reveals whether leverage is increasing or decreasing.
Economic Conditions: During high interest rate periods, lower ratios may be preferable to minimise debt servicing costs.
For investors, a stable or declining ratio generally indicates improving financial health and sustainable capital structure management.
Although the Long-Term Debt to Capitalisation Ratio is a reliable indicator, it has certain limitations:
Ignores Short-Term Debt: It excludes short-term borrowings that can still affect liquidity and risk.
Accounting Variations: Definitions of “equity” and “debt” can differ between firms and accounting standards.
Static Measure: The ratio reflects a single reporting date and does not capture seasonal fluctuations.
Industry Differences: Acceptable ratio levels vary widely across sectors.
Capital Structure Changes: Issuing new shares or refinancing debt can quickly alter the ratio.
Hence, this metric should be used alongside others such as the Debt-to-Equity Ratio, Interest Coverage Ratio, or Cash Flow to Debt Ratio for a complete financial assessment.
A company’s long-term funding mix reveals much about its financial stability and growth approach. The Long-Term Debt to Capitalisation Ratio highlights how dependent a business is on long-term borrowing to finance operations and expansion.
Key takeaways:
The Long-Term Debt to Capitalisation Ratio shows what proportion of a company’s funding comes from long-term borrowing.
It’s a key indicator of financial leverage, risk appetite, and capital structure strategy.
A lower ratio signifies greater reliance on equity funding and lower debt levels.
A higher ratio signals greater leverage — potentially riskier, but possibly more profitable if returns exceed borrowing costs.
Always interpret the ratio in the context of industry standards and historical trends for accurate insight.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
The Long-Term Debt to Capital Ratio includes only long-term liabilities in its calculation, whereas the Debt to Capital Ratio accounts for both short-term and long-term debt. The former focuses on structural leverage, while the latter provides a broader view of total financial obligations.
A Long-Term Debt to Capitalisation Ratio between 0.25 and 0.50 (25–50%) is generally regarded as healthy. However, this range can vary significantly depending on the company’s industry, capital structure, and business risk profile.
Yes, the ratio is applicable across sectors, but its interpretation differs. Capital-intensive industries such as infrastructure, utilities, and energy often maintain higher ratios, while service-based or technology companies tend to operate with lower leverage.
Preferred stock is usually included in total capitalisation, as it represents a hybrid form of financing. Minority interest may also be included, depending on consolidation practices and applicable accounting standards.
Companies should review this ratio quarterly or annually alongside other solvency and leverage indicators. Regular monitoring provides insights into capital structure trends and debt sustainability.
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