Debt to Capital Ratio

Debt to Capital Ratio is a type of Solvency Ratio that determines the contribution of Debt in a company’s Total Capital. It is a measure of the total debt of a company relative to its total capital. Creditor's contribution is termed as Debt and Debt along with total Equity is termed as Total Capital.
Debt to Capital Ratio = Total Debt / Total Capital
Where,
  • Total Debt = Long Term Debt + Current or Short-Term Debt; hence, total debt includes all debts/liability payable within a year and payable in the long-term.
  • And Total Capital = Total Equity + Total Debt; total capital implies shareholders as well as creditors contribution.

Significance and Interpretation

  • Debt to Capital Ratio =
  • For, Debt to Capital Ratio = 1, Total Equity must be Zero, which is not possible.
  • Hence, the Maximum Value of Debt Capital Ratio = 1
    • Debt Capital Ratio = 0.5: This implies that the Debt Contribute to 50% of the Total Capital or Total Debt is equal to Total Equity i.e. there is just enough Equity to cover all Debt.
    • Debt Capital Ratio <0.5: This implies that Debt contributes to less than 50% of the total capital and there is enough equity to cover all debts.
    • Debt Capital Ratio > 0.5: This implies that Debt contributes to more than 50% of the total capital, the company faces lots of issues in times when the interest rates rise.
  • The ideal Debt Capital Ratio < 0.5, which indicates that the company has less than half of the capital as debt (both current as well as non-current). However, it must be noted that this limit may shift depending upon the regulatory reforms and/or type of business.
  • A low Debt to Capital Ratio is beneficial for lenders to the company, wherein a high Debt to Capital Ratio is beneficial to the company for trading in Equities.


Examples

  • Example 1: M/S ABC Ltd. reported short term debts worth ₹80 Crores, long term debts worth ₹ 220 Crores and total equity as ₹450 Crores, find the debt capital ratio of M/S ABC Ltd
  • Solution: Total Debt = Short Term Debt + Long Term Debt = (80+220) = ₹300 Crore
  • Total Capital = Total Debt + Total Equity = (300 + 450) = ₹750 Crore
  • Hence, Debt Capital Ratio = Total Debt / Total Capital = 300/750 = 2/5 or 0.4


Example 2: The following information is available about M/S XYZ Ltd, find debt capital ratio of the firm.
Sr. No Particulars Amount (in ₹ Cr)
1 Current Liability 400.00
2 Non-Current liability 120.00
3 Share Capital 180.00
4 Money Reserved Against Share Warrants 800.00
5 Reserves and Surplus 50.00
  • Solution: Total Debt = Current Liability + Non- Current Liability = ₹520Crore
  • Total Capital = Total Debt + Share Capital + Money Reserved Against Share Warrants + Reserves and Surplus = ₹1030 Crore
  • Debt Capital Ratio = Total Debt / Total Capital = 520/1030 = 52/103
  • Hence, Debt Capital Ratio = 52/103 or 0.5
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